Life changes, and sometimes, those changes mean your home no longer fits your needs. Whether it’s a job relocation, growing your family, or downsizing after the kids have moved out, you may find yourself considering selling your home before your mortgage term is up. But before you list that “For Sale” sign, it’s essential to understand the costs and implications of breaking your mortgage contract early.
The Cost of Breaking Your Mortgage Contract
When it comes to selling your home early, the biggest factor to consider is the type of mortgage you have. The financial consequences can vary greatly depending on whether you have an open or closed mortgage.
Open Mortgages: If you have an open mortgage, you're in luck. These types of loans allow you to sell your home without facing penalties. You can pay off the mortgage in full at any time, which includes the option to sell your property before the mortgage term ends.
Closed Mortgages: On the other hand, if you have a closed mortgage, you will likely face penalties. The most significant of these is the pre-payment penalty, which is a fee for breaking your mortgage contract early. Depending on the terms of your mortgage, this penalty could be substantial—potentially thousands of dollars.
In addition to the pre-payment penalty, other costs may be associated with breaking your mortgage early, including:
Administrative fees
Appraisal fees
Reinvestment fees
Mortgage discharge fee (to remove the charge on your current mortgage)
If you received a cash-back incentive or a line of credit when you initially took out your mortgage, you may also be required to repay those amounts upon selling your home.
What Are Your Options for Breaking the Mortgage Contract?
If you're contemplating selling your home early, you do have some options to potentially reduce the financial burden:
Blend-and-Extend Option: Some mortgage lenders may offer a solution called Blend-and-Extend. This allows you to extend your mortgage term while blending the interest rates of your old and new terms. In doing so, you avoid the pre-payment penalty. However, administrative fees may still apply, and not every lender offers this option.
Breaking the Mortgage: If a Blend-and-Extend is not an option, breaking the mortgage contract may be your only choice. Although you might get a lower interest rate on your new home, you’ll need to factor in the pre-payment penalty and other associated fees. It’s crucial to weigh whether the benefits of breaking your contract outweigh the costs.
Pros and Cons of Selling Your Home Early
Selling your home before your mortgage term expires might sound appealing, but it’s important to carefully consider both the advantages and disadvantages:
Pros:
Lower Interest Rates: If interest rates have dropped since you first took out your mortgage, selling your home and buying a new one may allow you to lock in a lower rate, potentially saving you money over time.
Faster Payoff: If you’re able to secure a lower interest rate, and you continue to make the same mortgage payments, you might pay off your new mortgage faster than your old one.
Cons:
High Pre-Payment Penalties: The fees for breaking your mortgage before the term ends can be significant. Even if you secure a lower interest rate on your new home, the pre-payment penalties and additional fees could make this option more expensive than you anticipate.
Qualification Challenges: With the current economic conditions, there’s no guarantee that you will qualify for a new mortgage, especially if you’re downsizing or moving into a rental. It’s important to be aware of your financial situation before making any decisions.
What Does a Pre-Payment Penalty Look Like?
One of the most significant considerations when breaking your mortgage early is the pre-payment penalty. The amount varies depending on the interest rate environment and your specific mortgage terms.
If interest rates have risen since you signed your mortgage, you could face a hefty penalty. Lenders often calculate the penalty using an Interest Rate Differential (IRD), which is the difference between your current mortgage rate and the current rate for the remaining term of your mortgage. This difference is then multiplied by your mortgage balance.
For example, if you have a $300,000 mortgage balance with a fixed interest rate of 3% on a five-year term, and there are three years left in your contract, your lender will assess the current interest rates for three-year terms and calculate the difference. This difference could result in a substantial penalty, especially if rates have increased.
If you have a variable-rate mortgage, your penalty might simply be three months of interest payments. But for fixed-rate mortgages, it could be the three-month interest or the IRD amount—whichever is greater.
How to Minimize the Penalties
There are a few strategies you can use to minimize the penalties associated with breaking your mortgage:
Maximize Pre-Payments: Some mortgages allow you to make additional payments without penalties. By reducing your mortgage balance ahead of time, you may lower the pre-payment penalty.
Open Mortgages: If you have an open mortgage, there’s more flexibility to sell your home early without penalties. You may also want to explore open mortgages when refinancing, as they offer greater freedom.
Important Steps Before Selling
If you are thinking about selling your home before your mortgage term ends, there are a couple of steps you should take:
Request a Payoff Quote: Contact your mortgage lender to get a quote for the remaining balance on your mortgage. This will give you a clear picture of what you owe.
Calculate Your Home Equity: Determine how much equity you have in your home. This is the difference between your home’s market value and the remaining mortgage balance, and it could impact your financial situation when selling.
Final Thoughts
Selling your home before the mortgage term ends can be an attractive option if your needs have changed. However, it’s essential to understand the costs involved, from pre-payment penalties to additional fees. Consulting with a mortgage advisor and a real estate agent will help you navigate the process and determine if selling early is the right choice for your financial situation.
Take the time to carefully evaluate your options, weigh the pros and cons, and make sure the benefits of selling outweigh the costs. By gathering all the necessary information, you can make an informed decision that aligns with your long-term goals.
