How to break out of a mortgage commitment, part 1

Background:

A mortgage requires that you are locked in for a certain number of years depending on your mortgage agreement. Most likely you had committed yourself to five years. With this commitment, you agree to pay the lender a certain amount in interest which may be Fixed or variable. If this interest becomes too high relative to current mortgage, you may look into breaking out of it.

So in deciding whether you should break out of your mortgage is knowing all the FEES and how to work with or around it.

Fees:

1. Penalty Fee

This should be your biggest fee. Your penalty fee depends on your mortgage amount, interest rate and remaining years you are locked into the mortgage.

How Penalty Fee is calculated:

If your mortgage interest rate is the same or less then the current comparable rate, then you will be charged three months interest. By comparable, I mean fixed compared to another fixed and variable compared the variable. Otherwise, your calculation would be something like

number of years remaining * interest rate difference * mortgage amount.

I won't get into the details because you should always ask your lender what the exact amount should be and ask them how the calculation works.

Work around:

Since the penalty fee is always based on the mortgage amount, you should aim to make the largest prepayment possible. This will reduce the penalty fee by an equivalent percentage. So for example, if you can make up to a 20% prepayment. Then by doing so, you will reduce your penalty fee by 20%.

If you chose to break out of the mortgage, but still use the same lender, then you should not have make a prepayment. Your current lender should give you a discount because you are already using them and they are the once charging you this fee. Mathematically speaking, however, this discount is always equivalent to the prepayment amount. If the prepayment amount is 20%, then the discount amount is 20%. This actually means there is no special discount in terms penalty fee, if you are able to make the maximum prepayment amount.

Another thing you can do is risk and wait until the current interest rate climbs to the interest rate you are paying. Let's say for example, your fixed rate is 4%. If you believe that the interest rate for fixed will quickly climb to 4%, then you can pay the shorter fee of three months interest. This risk is that you could very well, be wrong.


Go To Part 2...

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