Breaking a mortgage for better rates can pay off – but beware of the costs

TORONTO – Interest rates are dropping, but many Canadians are still feeling the hangover of the highest lending costs in a generation.
For those stuck paying elevated mortgage rates, or who want to cut high-interest consumer debt, breaking a mortgage contract could make sense. But experts say borrowers need to watch out for what could be hefty fees.
The draw of refinancing comes as discounted fixed-mortgage rates have fallen from around 5.49 per cent last October to rates now being offered at just under four per cent for the most qualified borrowers, according to RateHub.
Securing that 1.5-percentage-point drop on a $400,000 mortgage balance would save about $338 per month.Reducing the interest rate on a $10,000 credit card balance from 20 per cent to four per cent would, roughly speaking, push monthly interest payments down to $33 from $167.
The potential savings come as both the Bank of Canada and the U.S. Federal Reserve have started lowering rates for the first time in more than four years now that inflation has subsided.
For those who locked in a rate near the peak, or who have had to add high-interest credit card and other consumer debt to manage through the cost-of-living crunch, it could pay to secure a lower rate or consolidate debt into a new mortgage, said Leah Zlatkin, a mortgage broker and LowestRates.ca expert.
“Certainly, there have been people who have acquired extra debt over the last couple of years and now that rates are coming down, it is an opportunity to refinance,” she said.
“Pay off some of those credit card debts that you’re paying out at, you know, 15 plus per cent, and put that into a mortgage instead.”
There are many Canadians who have had toturn to credit card debt, as outstanding balances hit $122 billion in the second quarter, according to Equifax, up 13.7 per cent from a year earlier. Balances grew more for those who were also paying a mortgage.
The financial strain of higher debt and borrowing costs helped push the delinquency rate for non-mortgage debt up 23 per cent from a year earlier, said the credit reporting agency.
But breaking a mortgage isn’t without its pitfalls, most notably because all the fees that go with it.
Some mortgages, including most with a variable rate, have a fairly straightforward penalty of three months of interest payments. But it can get more complicated with fixed rates where the charges can vary considerably by lender.
Many fixed-rate mortgages use what’s called an interest rate differential to help determine the cost, which will factor in how far along the mortgage is, and as the name suggests, the difference in interest rates from when the mortgage was first secured and when it’s being refinanced.
“It’s very nuanced. It really depends on you and your lender,” said Zlatkin.
Refinancing a mortgage will generally also involve legal fees, an appraisal charge, registration charge, and, if switching lenders, a discharge fee.
While the terms should be laid out in the mortgage agreement, Zlatkin recommends talking with a broker as there are numerous variables to factor in, including the timing around when to make the change.
If interest rates drop further, as they’re expected to, borrowers could face higher penalties on the interest rate spread.
But part of what makes now a potentially worthwhile time to consolidate is that fixed rates have already factored in the expected interest rate declines.
The current five-year Canadian bond yield, which helps determine fixed mortgage rates, is already pricing in the Bank of Canada cutting to 2.5 per cent from its current 4.25 per cent, noted a report by Beutel Goodman Investment Counsel.
If the Bank of Canada stops cutting rates at 2.75 per cent, which is in the middle of where the central bank thinks its policy rate will settle, then bond yields and fixed mortgage rates could rise.
The potential for changes in the outlook, such as if inflation starts rising again, means it’s important to lock in a rate early, said mortgage strategist Robert McLister.
“The market’s expectations can change dramatically,” he said. “So at least, you know, securing a rate now protects you in the event that inflation pops up in the next few months.”
As an alternative to mortgage refinancing, homeowners could also consider a home equity line of credit to pay down higher-interest debt, but McLister said that’s better as a short-term option. If it’s going to take years to pay off the debt, he said mortgage rates would likely be the better bet.
He said that while consolidating high interest debt into a mortgage can be helpful, he warns those struggling with poor credit, potential job loss or a falling home value might have trouble refinancing.
But consolidating debt at a lower rate should reduce how much needs to be paid each month. That would improve the debt service ratio and should help mortgage qualification, while being able to manage the lower payments could also boost someone’s credit rating, said McLister.
“If you consolidate debt and all of a sudden you’re paying off all of this revolving debt, that’s a good thing.”
This report by The Canadian Press was first published Oct. 3, 2024.