You're Not Actually Locked In (Even Though It Feels Like It)
If you have a fixed-rate mortgage, you probably think you're stuck until renewal day. But here's the thing: if rates have dropped since you signed, switching to a lower rate could save you thousands — even after you pay the penalty to get out early.
In today's market, some homeowners with higher fixed rates may benefit from exploring their options. Let's break down how this works and look at specific scenarios to help you figure out if breaking your mortgage makes sense.
How Fixed Mortgages and Penalties Work
A fixed-rate mortgage locks you into a set interest rate and monthly payment for a specific period, giving you stability and predictability. But if interest rates drop significantly during your term, you could be missing out on real savings.
Breaking a fixed-rate mortgage to switch to a lower rate means paying a penalty. The size of that penalty varies depending on your lender — and understanding how they calculate it is key.
Why Your Lender Type Changes Everything
Not all penalties are created equal. The two main lender types — monoline lenders and banks — calculate them very differently.
Monoline Lenders
Monoline lenders (like First National, Strive Capital, and MCAP) specialize in mortgages and generally don't offer other banking products. They often have lower rates than banks and can offer more competitive options for refinancing.
For monoline lenders, the penalty for breaking a fixed-rate mortgage is typically calculated using the Interest Rate Differential (IRD) — the difference between your current rate and what the lender offers today for a term matching your remaining time. This usually results in a lower penalty.
Banks
Banks calculate IRD penalties differently, often using their posted rates (the inflated ones nobody actually pays). This can lead to significantly higher penalties when breaking a fixed-rate mortgage with a bank compared to a monoline lender.
In summary: monoline lenders base IRD on their actual rates for the remaining term, which tends to mean lower penalties. Banks often base it on posted rates, which can inflate the penalty amount.
A Real Scenario: 5-Year Fixed with 3 Years Left
Let's look at a scenario to see how breaking a fixed-rate mortgage could work in practice. Suppose you have a 5-year fixed-rate mortgage with an initial principal of $500,000, an interest rate of 5.69%, and 3 years remaining. Your penalty to break is $3,000, which can be rolled into the new mortgage.
Current rates for comparison: a 5-Year Fixed Rate (Insurable Transfer) at 4.39%, and a 5-Year Variable Rate (Insured Transfer) at Prime minus 0.90%, which is currently 5.05% (based on Prime at 5.95%).
Running the Numbers
At your current rate of 5.69%, your monthly payment is approximately $3,141. Over the remaining 3 years, you'd pay about $49,125 in interest.
If you refinanced to 4.39%, your new monthly payment would be approximately $2,759. Over the same 3 years, you'd pay about $42,060 in interest.
Potential savings over the remaining 3 years: $49,125 (old rate) minus $42,060 (new rate) equals $7,065 in interest savings. Subtract the $3,000 penalty (rolled into your new mortgage), and your net savings is $4,065.
In this scenario, by paying the penalty to break the mortgage and switching to the lower fixed rate, you could save $4,065 over the remaining 3 years.
What About a Variable Rate?
If the 5-Year Variable Rate at Prime minus 0.90% (currently 5.05%) is appealing, you could also explore a variable rate option, which may offer additional savings as rates potentially decrease. Keep in mind that variable rates fluctuate with the market, so this option is best suited for those comfortable with some payment variability.
Who Should Consider This
Breaking a fixed-rate mortgage isn't for everyone. To qualify, you should meet the following criteria: your fixed-rate mortgage should be at least 1 year old, you should have no late payments on your mortgage, and your current mortgage rate should be higher than 5%.
If you meet these criteria, this strategy could provide significant savings, even after accounting for penalties and potential legal fees.
How to Get Started
If you're considering breaking your fixed-rate mortgage to take advantage of lower rates, start by calculating your penalty. Reach out to your lender (or check your lender's portal) to determine your penalty for breaking the mortgage. For monoline lenders, this should be a straightforward IRD calculation based on your lender's actual rates for the remaining term.
Once you have your penalty information, contact me via email or book a call. I'll review the numbers and perform calculations to see if switching makes financial sense for your unique situation. Together, we can assess potential savings and identify the best options based on the current rate environment.
Where rates are today
Reading about rates is one thing—seeing today's is another. See today's live mortgage rates, updated every morning from every lender we work with, along with our forecast on where fixed and variable are heading next and a live fixed-vs-variable breakdown. If you're closing in the next 120 days, that's also where you'll find the free rate hold.
