How to Save Money When Refinancing A Home Mortgage

by Mr. Cheap

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I recently guest post about refinancing home mortgages that is a topic I’ve recently been interested in. As with many financial issues, there isn’t an easy answer whether you should do this or not, and it depends heavily on your personal situation and how much risk you’re willing to expose yourself to with respect to future inflation and interest rate changes.

If you *DO* decide to break your mortgage, there’s an easy way you can save yourself a chunk of the penalty, assuming you have the right mortgage features.

Refinancing your home mortgage

First, to give a general overview, breaking a mortgage typically entails paying the lender three months interest as a penalty (in Canada at least). More recently, they have begun using an alternative method for calculating the penalty called the interest rate differential (IRD). This is simply how much they WOULD have made off of you if you’d kept paying on the mortgage (and these days is higher than 3 months interest).

Whether or not to make the change is a fairly simple calculation (compare the penalty to the interest savings). The big additional benefits that attract me to the idea is that it’s a great time to get a fixed rate (in case interest rates take off). I’d actually be tempted to pay a premium and get a 10 year mortgage and not have to worry about interest rates for the next decade.

Some might try to make this a moral issue, claiming you’ve made a commitment to the lender and should honour it. This is garbage. Part of your commitment (check your mortgage documents) is that you can break the mortgage if you’re willing to pay the penalty. If they didn’t want you doing so, they shouldn’t have included it as part of the agreement.

I’m currently house hunting, so getting a new mortgage would be a dangerous thing. I will definitely investigate any impact refinancing might have on getting a new mortgage before I did anything.

Getting back how to save money when breaking a mortgage. When I called PC Financial (my mortgage holder), and asked about refinancing they told me it would cost $1,190.19 for me to break it (my mortgage is a little more than $89 K). I am allowed an annual 20% pre-payment, so I asked the rep what the penalty would be if I maxed out the prepayment first, which promptly dropped it to $882.70. He certainly didn’t volunteer this information, but he had it right there, so definitely ask (if you can pre-pay) how much it would lower the penalty fees.

For me personally, I’d just get the 20% out of my line-of-credit (then pay this off with the new mortgage). Even if you got the money from a high interest source (like a credit card cash advance or something) I think it would still be a good way to lower the penalty (in my case it’d save me 25%), as long as you quickly paid it back.

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{ 6 comments… read them below or add one }

1 Mike

Good tip!

We did this very thing when we sold my wife’s house – our lawyer suggested it. Unfortunately it backfired since the buyer couldn’t close on time and ended up delaying the close by about 10 days which eliminated all the potential profit (because of extra interest).

Not only that but at the time we had 2 houses + 1 huge renovation loan and I used up the last bit of credit for that move. If the guy had delayed another week I would have had to apply to the bank of “Mom & Dad” for some temporary cash….luckily it didn’t quite come to that. :)

2 Million Dollar Journey

Thanks for the mention and great tip!

3 MM

Good idea! Although I just sold my place two weeks ago and was dinged huge with the Interest rate differential. I’m not buying again either so I can’t recoup the cost. But the difference between 3-month penalty and IRD was $4k!

4 DAvid

Interestingly, when we paid our mortgage off early, our bank automatically applied a double-up, and the maximum prepayment before calculating the penalty. WITHOUT being asked.

DAvid

5 as

If you have good relations with an experienced/willing account manager at the bank you may convince them to pay less than the prescribed penalty. Especially if you transfer an account from another bank / sign up for another product from them / etc. Also, I know of at least one case in which some of the penalty money was refunded when the client took a new mortgage with the same bank a short time afterwards (which may apply to anyone currently house hunting?!).

I also always took advantage of those 1.99% (or so) cheques your credit card company may offer you from time to time (ensuring, of course, that I charged no purchases to it during the loan, and skipping those new-card offers that charge a loan fee for their ‘generous’ promotion), and prepaid / doubled up the regular payments as much as I could.

6 Lisa Collins

Great advice! Always ask your bank what your cheapest option would be. We all need to be watching where out money goes in slower economic times as well as when the economy is healthy.

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