Breaking A Fixed-Rate Mortgage: Can And Should You Do It?

Can you break a fixed-rate mortgage – and when does it make sense to break this type of home loan agreement?

The quick answer is yes, you can certainly break the loan agreement on your fixed-rate mortgage before its term period expires, but it’s not always a recommended choice to do so. At the same time, with fixed mortgage rates continuing to hover around all-time lows, many current homeowners may find that doing so will prove a helpful tool that can help put money back in their pocket. Knowing how and when to break a fixed-rate mortgage is therefore an important piece of information to keep in hand.

In effect, if you currently hold a home mortgage, you may be paying more than you need to – and determining whether you can break a fixed-rate mortgage will be an important question to ask. That’s because if you break a fixed-rate mortgage, you may be able to save thousands in monthly mortgage payments each year, let alone over the lifetime of the loan. To find out more about whether you stand to benefit (and just how much money you can potentially put back in your pocket) by reorganizing or refinancing your mortgage debt, simply read on. It’s important to note that while many lenders have prepayment penalties, Rocket Mortgage^® does not.

A fixed-rate mortgage is a type of home loan in which a borrower agrees to borrow a certain amount of money from a financial lender (like a bank, credit union or online provider) for the purchase of real estate property.

Under its terms, the interest rate which you will pay on the mortgage (monies charged for the servicing of the loan and the provision of these funds by the lender) is locked at the time of closing.

This interest rate – which, unlike the ones attached to a variable or adjustable-rate mortgage (ARM), won’t fluctuate over time – essentially defines how much money you’ll pay in monthly interest fees for the term of the loan. Fixed-rate mortgages typically come in 15- or 30-year terms, but you can also get a custom term that’s fixed as well.

As alluded above, the answer is affirmative: You can break a fixed-rate mortgage before the end date set by the lender is reached and the term of the loan is completed. In fact, doing so could potentially save you thousands of dollars in interest payments in any given calendar year or over the total lifetime of the repayment period.

Bearing this in mind, it’s not uncommon for many homeowners to wish to break their fixed-rate mortgage if market rates drop and more favorable interest rate options become available at a future date. In fact, given that market rates currently continue to remain near record-setting lows, you may already be contemplating if it’s possible to break your mortgage and switch to a lower rate. After all, breaking your current mortgage and porting over to a new loan product with a lower interest rate could shave hundreds off your interest payments annually or even reduce the term of your mortgage (and accelerate your path to full homeownership) by several years’ time.

At the same time, it bears noting: Mortgages are complex financial instruments with legally binding terms attached. Choosing to break one isn’t a task that should be undertaken lightly, especially as doing so can come with penalties attached. Rather than simply move to break your mortgage the moment that a seemingly better offer presents itself, the correct approach to take here is to sit down and do some math instead. If you’ve run the numbers and found that they add up (i.e. made sure potential savings outweigh potential drawbacks), you’ll then want to make a call to your financial lender to see what options are available to you.

As a general rule, the process of breaking a fixed-rate mortgage will see you following several common steps:

1. Determine your overall goal. Ask yourself: Are you looking to reduce the total cost of your monthly payments? Shave thousands off your total mortgage cost? Change the time horizon over which you aim to pay off your loan? Once you have a clearer understanding of what it is that you’re looking to accomplish, you’ll get a much better sense of the financial options available to you. Note that you may also wish to take a hybrid approach to your savings strategy here. This could include looking to reduce your monthly payments over an identical period of time from one mortgage loan to the next, you could also try keeping monthly payments the same while reducing the number of years it takes to pay off your loan.
2. Consider your potential savings. Once upon a time, the rule of thumb was that it made sense to break your fixed-rate mortgage if you could get a new rate that was one to two points lower than the current rate. But rates have dipped so low now that you may wish to reconsider changing mortgages even for a smaller percentage dip, as savings may be proportionate depending on the term length of your loan. That’s why it’s important to run the numbers and get a complete sense of how much you stand to save, as – depending on your mortgage amortization term – even rate dips under a point could save you hundreds each month in interest payments.
3. Consult with your lender. At the time you agreed to take on a mortgage and signed corresponding documents, you agreed to be bound by a variety of legal terms and conditions. Hidden among them you may find a provision that says you’ll pay a penalty if you break your mortgage before your current payment schedule’s complete term is up. That’s right: Even if you’re paying off the entire balance of your loan in cash, or refinancing, you may be on the hook for thousands of dollars in penalties if you deviate from the repayment schedule you agreed to with your lender. (Because doing so produces less in interest payments to the lender than were anticipated and agreed to.) Noting this, it’s important to consider under what terms your current mortgage has been issued and how much breaking your present-day home loan may cost you. Rocket Mortgage^® does not have any prepayment penalties.

Given often hefty prepayment penalties that are designed to protect lenders (which count on regular interest payments from you over a predefined period to meet their own financial goals), deciding to break a fixed-rate mortgage isn’t a decision that should be undertaken lightly. At the same time, choosing to opt out of these contracts is also a common decision that millions of other borrowers happily make each year. In fact, there are many reasons besides simple interest rate savings that homeowners may wish to get out of their fixed-rate mortgage and obtain a new mortgage instead. Some of these reasons may include:

• A desire to engage in early repayment of their full mortgage balance
• The wish to refinance and obtain a loan with a different amortization term or conditions
• A wanting to change one’s mortgage lender
• An unexpected change in living situations or financial circumstances
• The need to free up more monthly income for bills, education or investments

As with any other financial decision related to real estate investment, breaking a fixed-rate mortgage comes with potential advantages and disadvantages attached.

Pros

• Potential to obtain thousands in interest rate savings
• Ability to lower monthly payments
• Capability to adjust mortgage loan term
• Power to access a loan under new terms and conditions

Cons

• Requires upfront research and planning
• Penalties and fees can quickly add up
• Need to engage in additional due diligence
• May come with added terms and clauses attached

As mentioned above, depending on your lender, breaking a fixed-rate mortgage may come with penalties attached – and these penalties can quickly add up.

For example: Variable-rate mortgage holders might expect to pay 3 months of interest (and potential additional fees) as a penalty.

But penalties on fixed-rate mortgages are often higher, requiring you to pay whichever figure is larger: (a) 3 months’ worth of interest payments, or (b) the interest rate differential (IRD) between the fees tied to the interest rate you pay on your current mortgage compared to those tied to the new mortgage you plan to obtain. As a general rule of thumb, this differential – which can often exceed 3 months of interest rate fees by several thousand dollars and run into four- or even five-figure sums before additional charges are applied – is often considerably higher.

Be advised as well: Refinancing or breaking a fixed-rate mortgage to switch to a new loan product also comes with additional costs attached, just as when applying for a first mortgage. Doing so means having to go through a background and credit check and having to pay appraisal, inspection and title fees again. As you may have noted when you obtained your first mortgage, these fees can easily run you upwards of $1,000 or more.

Taking these factors into account, before you break your fixed-rate mortgage (which will vary by individual lender), be sure to reach out to your financial lender and ask them to help break down the numbers for you. As a result of these calculations, you’ll be able to tell at a quick glance whether the penalties you may be charged are justified in light of the potential gains you stand to receive. In the end, the real question that the decision to break a fixed-rate mortgage will come down to isn’t whether or not you can do so, but how much it may cost you in total to make the change.

Once you’ve opted to get yourself out of a fixed-rate mortgage, you may wish to pay off the balance in cash (allowing you to secure ownership of the home outright) or explore additional home mortgage options. For instance, many borrowers elect to go with adjustable-rate mortgages (ARM).

Under the terms of an ARM, interest rates can change with the market, though the monthly payments attached to your loan will always remain the same. You may be charged less interest during an introductory period with an ARM (requiring a lower initial monthly payment), and – if rates go down – less over the life of the loan. However, if interest rates go up, an ARM can conversely become more expensive instead.

Interest rates attached to fixed-rate mortgages remain near all-time lows, creating many opportunities for new home buyers. However, those currently locked into fixed-rate mortgages at higher rates may be looking on in envy. Happily, the option to break a fixed-rate mortgage remains a possibility. Run some numbers and you may find that – despite the often hefty prepayment penalties attached to breaking a current home loan – it makes good financial sense to break your existing home mortgage and port over to a new loan product.

While significant administrative and penalty fees associated with doing so mean that it won’t always make sense to break a fixed-rate mortgage, significant savings opportunities mean that it’ll make perfectly good sense to do so at other times as well. If you’re interested in finding out whether or not it makes sense to break your fixed-rate mortgage, be sure to do some financial calculations and consult with your financial lender today.

Interested in learning more about current mortgage rates? Be sure to check back frequently here at Rocket Mortgage^®.