Most people shop for mortgages looking only at the interest rate. While that is important, term selection is actually the key to saving you the most money. There is no point fighting for a 2.64% vs. 2.69% 5-year fixed rate to save $700 over 5 years, but then turning around and paying $10,000 in breakage penalties when you sell it in 3 years. One of the best ways to save money on your mortgage is avoiding breakage penalties. You do this by aligning your mortgage product and term to the ownership horizon of your property.
Penalties - Why Term Selection Is So Important
Prepayment penalties would not matter if they were small and no one ever paid off mortgages early, but they can be huge! Depending on your mortgage size and how early you are paying it off, the penalty can amount to tens of thousands of dollars. You may think you have no intention of paying off your mortgage early, but things can change. You may need to sell due to a growing family, divorce, or death in the family. Or you may simply want to refinance to get a lower rate. Any of these things can result in you paying a prepayment penalty.
Most closed fixed-rate mortgages have a prepayment penalty of 3 months interest or the Interest Rate Differential (IRD) charge, whichever is HIGHER. To calculate the IRD, the bank subtracts the mortgage rate you originally agreed to pay from the rate it can charge today, and then multiplies that by the current balance of your mortgage and time remaining to your mortgage maturity or renewal. Generally, non-bank lenders charge lower penalties than the big banks in Canada but they can still be hefty.
A variable rate mortgage has a prepayment penalty of 3 months interest, a far smaller penalty than most IRDs today.
Dont Limit Yourself To A 5-Year Fixed
The 5 year fixed is great...if you actually plan to be in your home for 5 years. If you do not know how long you will own it or believe it will be a shorter time, consider a shorter-term fixed rate mortgage. For example, you could get a 1, 2, 3, or 4-year term. For even more flexibility of exit, consider a variable-rate mortgage because of its lower penalty.
Portability is a feature that allows you to move your mortgage to a new property to avoid or be credited back for a breakage penalty. It is an important feature because it can protect you from a significant cost. BUT keep in mind each lender has different policies and restrictions on their portability. Some do not offer portability at all (often value or discount mortgage rates). Lenders also differ in how much time can be between the sale and purchase to use portability, and have different rules about the rates and options available to you on any new mortgage funds you need over and above the current balance you are porting. So even if you have a portable mortgage, you may find you are not able to actually use the feature. Term selection still matters!
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