When you are thinking about what type of mortgage to get, one thing to ask your mortgage consultant is how much it will cost to break that mortgage.
By "breaking your mortgage" what I mean is for example, if you sell your house and pay out the mortgage or if you wind up with a large lump sum of money and you want to pay out your mortgage.
In either of these examples, you want to get out of your mortgage. Well that's going to cost you. And these costs can be relatively small or pretty significant.
Here is how to calculate how much it will cost to break your mortgage.
First thing it to find out how your bank/credit union (lender) charges the penalty for breaking a mortgage. There are two ways, 3 months Interest or Interest Rate Differential (IRD).
1. 3 Months Interest Charge
Say you have a 2.4% variable 5 year term on your mortgage, and you want to pay it out at year 2. You will have 3 years remaining on your mortgage, and at that time you have $500,000 remaining.
3 Months Interest = ( $500,000 x 2.4% ) / 4 = $3,000
2. Interest Rate Differential Charge (IRD)
In this situation, say you have a 3.39% fixed 5 year term on your mortgage, and you want to pay it out at year 2, with 3 years remaining. They take your interest rate, subtract the current rate that's available, and multiply by the months remaining and balance.
IRD = 3.39% - 2.05% = 1.34%
(1.34% / 12 ) x 36 months x $500,000 = $20,100
The take home message here is that you should know, before signing your mortgage, how much it will cost you to break your mortgage. It can be the difference between paying out $3,000 versus $20,100.
Know before you sign.
Check out this great video for further explanation.