Every time the interest rates hit record lows, it becomes an opportunity for Canadians to focus on getting a mortgage – buy or refinance. Whatever the case may be, securing a low-interest rate mortgage makes sense. It could amount to thousands in savings over a long period.

The Bank of Canada slashed its key lending rate from 1.75% to 0.25% in just a month in the recent past. But if you are under the impression that every borrower tapped into the lower rates to save money, you might be wrong.

There are always two sides to a coin. In this case, too, lower interest rates may look attractive, but an uninformed decision can lose you money. While the decision to renew early depends on one’s unique situation, people’s most common mistake is failing to account for additional costs, prepayment penalties, and legal fees.

Let us discuss the topic in detail with simple examples. In confusion, get professional help, use online calculators or follow this article to read more about every aspect of early mortgage renewal.

When is The Right Time To Renew Your Mortgage?

Most mortgage lenders offer to renew your mortgage within the term’s final 60 to 120 days without any prepayment charges. The mortgage term varies from a few months to 10 years. In Canada, five-year terms are the most common.

Let’s assume you get an attractive offer to refinance your mortgage with a rate less than .60% of your existing mortgage, and you have a $250,000 balance on your fixed-rate mortgage with 20 years to go.

With a 2.69% interest rate, you have to pay $30,186.90 in interest for five years and a monthly payment of $1,346.

Whereas, at a 2.09% interest rate, you will pay $23,342.55 in interest for five years and a monthly payment of $1,274.

You will save around $7,000 in interest by refinancing your loan. However, suppose you break your mortgage contract before the stipulated time (renegotiate). In that case, you may have to pay closing charges, prepayment penalties, and other legal fees depending on the type of mortgage.

At the end of the term, lenders notify the borrowers about their refinancing options. Furthermore, they also notify any changes in the rates. While many borrowers give a go-ahead signal to the lender, it is always advisable to compare rates to get a better option.

Costs Associated With Renewing Your Mortgage Early

The decision to refinance your mortgage early depends on several factors such as remaining term, principal and type of mortgage. Many homeowners fail to do the math and end up losing money. The fees associated with early refinancing can easily outweigh your interest savings on a new mortgage.

If you have decided to renew the mortgage early, you may have to pay the following costs.

Prepayment Penalty

A prepayment penalty is incurred on preclosure of the mortgage before the term ends or paying more than prepayment limits specified in contracts. In our case, we want to pre-close our loan to avail of a better rate. Therefore, the prepayment penalty will be calculated as below:

Variable-Rate Mortgage

If you have a variable-rate mortgage, you have to pay a prepayment penalty equivalent to three months of interest on an outstanding balance.

For instance, prepayment penalty for an outstanding balance of $200,000 at an interest rate of 6% will be:

Formula: Mortgage Rate × Mortgage Balance × (3 months/12 months) = 3-month penalty

Example: 6% × $200,000 × (3 months/12 months) = $3,000

Fixed-rate mortgage

Whereas, If you have a fixed-rate mortgage, the prepayment penalty will be the higher of three months’ interest or the interest rate differential (IRD).

The IRD is the difference between your mortgage agreement rate and your lender’s current rate, multiplied by the remaining months left in your term.

Formula: (Agreement Rate – Current Rate) x Mortgage Balance x (Months Remaining/12) = IRD

Example: (6% – 4%) x $200,000 x (36/12) = $12,000

The interest rate differential (IRD) will be $12,000 as this is a higher amount.

You can use a mortgage calculator to quickly calculate the savings or charges you will incur from changing to a lower interest rate.

In addition to the prepayment penalty, if you choose to switch the lender, you may have to pay:

• Setup fees which include registration, transfer or assignment, and discharge fees. The discharge fee ranges from $250 to $300.
• An appraisal fee (if necessary)
• Other administration fees
• Mortgage loan insurance premiums, if the loan amount increases or you extend the amortization period.

How to Make Most Of The Early Renewal When Interest Rates Drop?

Until now, it is clear that blindly jumping into the early mortgage renewal when interest rates drop is not a smart move. Instead, consider the following aspects to get the most out of early mortgage renewal:

Interest Rate

While the decision to renew early depends on the borrower’s unique situation, locking in a new rate that is at least 1% less than your current rate is viable.

Upfront Costs

The sole purpose of early renewal is to save on interests. Therefore, calculate the upfront costs, including prepayment penalties and other charges. Typically, it ranges from 3% to 6% of the loan amount.

Mortgage Term

Do not underestimate the power of shortening your loan term. You will pay higher monthly payments in a shorter repayment period, but you will save thousands in interest in the long run.

Endnote

Early renewal of a mortgage is more than just getting an attractive rate. It requires careful planning, calculations, and in-depth analysis..

The most important thing, ask yourself, “ Do early mortgage renewals save or cost you money?” If the savings from renewal outweighs the upfront costs you pay to break the contract, then renewal makes sense. Otherwise, there is no point in wasting your time, resources, and ultimately money.