Early Mortgage Renewal / Refinance

Why It Sometimes Makes Sense to Break Your Contract and Negotiate a New One

First to understand is that most mortgage contracts on residential homes are "closed" terms, meaning that if you want to make changes before the term maturity date, you have to break the contract, and that often comes with a payout penalty. 

If you were to break your contract, the question then becomes: how much is the payout penalty and can you at least recover the penalty in savings or otherwise justify it.

There are a few scenarios where you might want to consider Early Renewal/Refinance:

1. You want to take advantage of lower interest rates in the market, which can help you be mortgage-free faster, or you preceive that rates will likely increase before your next renewal date and you want to limit your exposure.
2. You need to make other changes to your mortgage, such as buying out a spouse in a divorce situation, or you have a need for money and want to access equity in your home, etc.
3. You want to reduce or better manage your monthly mortgage payment to make it more affordable.

On this page, we are going to talk predominantly about scenario 1 (saving you money), but it is the same financial analysis that can help you to decide whether or not to consider breaking your mortgage contract early for other reasons.

How to Take Advantage of Interest Rate Arbitrage Opportunities

What is Arbitrage?

Arbitrage is a financial term used to describe situations where you can retain the same financial benefit (in this case a mortgage loan on your property for a specified period of time) by simultaneously taking advantage of two different markets (switching from one mortgage lender to another) and their pricing for the same benefit.

Put practically, if you can get rid of an interest rate obligation - say - at 3.74% for the next 3 years and replace it with a new mortgage at 2.59% for the next 3 years, plus rate protection for 2 more year beyond that, and penalty for breaking the existing mortgage contract can be recovered in savings and then some,  congrats - you have successfully captured an arbitrage opportunity! (PS - we can help with the analysis, in case you were starting to get worried).

How or Why do Arbitrage Opportunities Happen?

You might be wondering how these "arbitrage" opportunities manifest. A lot of that can be explained by understanding how your particular lender will calculate their payout penalty in the event that you terminate your contract and go elsewhere.

When there is a significant change to interest rates in the mortgage market, many lenders drop (or raise) the interest rates first on their 5 year mortgage terms followed by changes to their shorter-term mortgages. Additionally, some lenders make rate changes faster than others. 

Lenders will use the rate that they offer for the term length that is closest to the time remaining in your current term to calculate your payout penalty, so if your current lender is slow to respond to changes in the interest rate market with their shorter term rates, an early renewal arbitrage opportunity may exist.

The opportunity or goal is catch your lender sleeping and lock in a new lower rate with a different lender while simultaneously getting your current lender to calculate your payout penalty using stale interest rate values in their own formula (basically, you want the interest rate differential or IRD to be narrow). Some or all of the penalty can often be rolled into the replacement mortgage balance and easily recovered through interest savings along with your arbitrage profit! 

This same phenomena also manifests in variable rate mortgages, where the discount to Prime rate changes over time. For example, you might have a Prime less 0.4% mortgage contract with 3 years remaining and the market changes and Prime less 1.0% becomes available from a different lender. The question would be, can the 0.6% rate reduction for the years remaining in your contract more than recover the payout penalty you will face for breaking the existing contract?

If you want a refresher on mortgage payout penalty calculations and term selection, please review: https://www.richardsmortgagegroup.ca/mortgage-contract-term

How to Determine if a Savings Opportunity Exists?

Great question! The answer is there is a Cost-Benefit-Analysis (we can do it for you) where we compare the present value of the sum of the monthly savings from a lower rate against the cost to break your current mortgage contract. If we think about it another way, it would be the present value of the difference in your mortgage balance at the end of your existing term if you had the new lower rate compared against the cost to access that new lower rate (holding payments constant).

*Present value means all money calculations are converted (discounted) to today's dollars to make the comparison apples-to-apples.

For example, if the potential savings are $5000 and the transaction costs (including payout penalty) are $2000, then the net benefit of this strategy is $3000. To capture this benefit, there is effort required on your part: you have to be able to qualify for a new mortgage (application and credit review), and there is some paperwork to collect (employment & tax documents). That being said, if it takes you a cup of coffee and 2 hours of work to capture $3000, is $1500/hr sufficient compensation for your time? Or put another way, if over the life of your mortgage and by being proactive, you could shave years off your mortgage and retire a few years earlier, would that be worth the effort?

The standard analysis assumes that you put the savings back against the mortgage balance and reduce your mortgage interest expense, but if you could use those savings to pay down higher interest debt such as a large credit card balance, then your return is even better. Since money saved is money earned, high interest payments saved are high interest rates earned. 

Note: although the above analysis assumes an early renewal scenario where no additional money is borrowed, it works equally well in a refinance situation where you need to borrow extra money against your property. In that case you are simply getting two birds stoned at once by switching your mortgage to a new lower rate as described above while also borrowing extra money at that same low rate. 

In the following video, I am going to explain the cost-benefit-analysis methodology and try to clarify an important point about the highest and best use for the savings that manifest from the Early Renewal strategy.

How to Begin the Early Renewal/Refinance Analysis

To accurately perform the cost-benefit analysis, there are key pieces of information about your current mortgage that we will need before any calculations can be done. 

• current mortgage lender
• mortgage payment and payment frequency
• current mortgage balance 
• interest rate
• mortgage type (fixed or variable)
• mortgage maturity date
• mortgage payout restrictions if any
• original mortgage balance (from your last renewal date or when the mortgage was put in place)
• remaining amortization

You can get this information from these 3 sources:

1. your most recent Annual Mortgage Statement 
2. your original Mortgage Commitment or Renewal Letter from the last time time you changed the mortgage, and
3. online from your lender

Additionally,  standard income, credit, equity, and property qualifying criteria must be satisfied.

If you would like us to perform the analysis, we can send you an email with the above information and instructions on where to find the info on the statements mentioned. Reach out to us below by providing some initial information about your situation and if an opportunity exists, we will be in touch to explore your options in more detail and provide instructions on how to obtain a payout statement from your lender.    

Free Analysis

Managing the lifetime cost of your mortgage can provide significant value relative to effort. A couple hours of work on your part could save thousands of dollars. Money saved is money earned! We are also available via the chat bubble to your right or call us at 1.888.540.1715