August 15, 2012

How Mortgage Prepayment Charges Can Affect a Future Purchase

As a first-time home buyer, you might not be thinking ahead to when you buy your next house and what will happen to your existing mortgage. However, the terms of that first mortgage will affect your future options. Depending on the type of mortgage you get (such as a fixed rate, closed mortgage), there is usually a prepayment charge. This is the extra charge or “breakage cost” that is applied if you get out of the loan before its maturity.

Let’s say you’ve lived in a condo, a starter home for 3 years, but have decided to upgrade to a larger house with time left on your mortgage. What are you options? How can you avoid the prepayment charge?

Well, if you are negotiating your first mortgage but think that you will likely want to buy a new home in the next few years, you may be thinking about getting an open or variable rate mortgage. This is something important to discuss with your lender or Mortgage Broker/Specialist. Typically open mortgages do not have a prepayment charge. If you have a closed mortgage, you should know how the prepayment charge will be calculated. This usually depends on how much time left you have and what the original interest rate is.

If you’re in a situation where you believe it’s more beneficial to break a current mortgage – and pay the charge – as getting a new one with lower interest rate will actually save more, be sure of your timing! Many people are shocked by how much the charge is as the figure they get from their lender may be vastly higher (many institutions do not give you an exact formula of how they calculate this rate) than expected. Be wary too of the time elapse while thinking about accepting the fee; this rate can continue to climb as you decide – know when the deadline is!

Even if you plan to pay off the existing mortgage with the sale of the home, a prepayment charge may apply if you’ve not yet reached the term of your closed mortgage. You may want to consider carrying over your mortgage to the new home. Most lenders offer mortgages with “portability”, in which financing can be transferred without penalty. Typically you keep the same interest rate to the remainder of the term on the new home.

There’s lots to think about when it comes to getting a mortgage – even looking years ahead to keep options open for your future self. The best thing to do is to get professional advice from a Mortgage Specialist or Mortgage Broker, who can help you decide what’s best for your financial needs.