Marc and Isabelle have a $300,000 mortgage with the ABC Bank. They planned to pay off their house in 25 years. They took a loan at a fixed rate of 3.45% on a 5-year term. Two years before the date of maturity, the XYZ Bank offered them a rate of 2.34%. Should they break their current mortgage agreement to change lenders?

Before you break your agreement, you should first consult with your current lender to find out the cost of their prepayment penalty, which is calculated on the remaining mortgage balance. Two factors are considered here: the term before the end of the contract and the gap between the interest rates. Specifically, the longer the term is to maturity, the higher the penalty will be. Also, the bigger the gap between your interest rate and the current market rate, the higher the penalty will be.

If the charges incurred to break your mortgage loan are higher than the interest saved by renegotiating your loan, you are better off staying with your current lender. However, if the interest savings are greater, terminating your contract may be beneficial.

Pros and cons of terminating a mortgage loan

When banks announce a decrease in their interest rates, you may be tempted to cancel your mortgage contract. But before doing so, take the time to weigh the pros and cons.

Pros

• You benefit from a lower interest rate.
• If you maintain the same mortgage payments, you will pay off your mortgage faster.

Cons

• A short-term liquidity loss (payment of the penalty) for medium-term savings.

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