Can you break a fixed-rate mortgage?

For most homeowners, the consistency of a fixed-rate mortgage makes it a very attractive loan option. Your interest rate is locked, your monthly payments are predictable, and budgeting is easier.

But if market conditions or your financial situation changes, a fixed-rate mortgage can sometimes feel like a bad deal. For instance, if mortgage rates drop, you may feel like you’re stuck paying too much.

When circumstances change, you might wonder if you can break your fixed-rate mortgage. In short, yes, but the decision is a big one that deserves careful consideration. A mortgage is a legal contract, so breaking it early can incur penalties. On the other hand, the penalty could be worth it if the amount you save over time is much greater. And, if you have an open mortgage, you may be able to pay it off early without penalties.

What is a fixed-rate mortgage?

A fixed-rate mortgage is exactly what it sounds like. It’s a home loan in which the interest rate stays the same for the entire term of the loan. So, whether you have a 10-, 15-, or 30-year term, your mortgage rate does not alter, even if the market rate does.

The stability of a fixed-rate mortgage makes it very popular, especially for those who want a more predictable payment. You are insulated from times when interest rates rise – your monthly payment for principal and interest remains the same.

Of course, when interest rates drop, yours does not. It, along with your monthly payment, stays the same. So, in times of dropping rates, you might feel like you’re losing money by paying too much.

Some mortgages do adjust with the market, however. These are called adjustable-rate mortgages (ARMs), and they move up and down with market fluctuations, according to specific pre-determined terms. With an ARM, you give up stability for the chance at a lower rate if interest rates fall. But you risk your interest rate rising if rates increase.

Can you get out of a fixed-rate mortgage?

Yes, you can break a fixed-rate mortgage, but there may be consequences. But there are many common reasons homeowners routinely break their fixed-rate mortgage. They include wanting to refinance to a lower interest rate and monthly payment, moving to a different lender, paying off their loan early to save on long-term interest, restructuring their finances, or selling their home.

A mortgage is a legal contract, and you are obliged to its conditions. Often those conditions include a penalty for breaking a mortgage early. The penalty is typically either three months’ worth of interest on your remaining balance or an interest rate differential (IRD). An IRD compares your current rate to current market rates and imposes a penalty based on the difference and your loan's time to maturity. This can often be a large amount.

It’s also key to understand the difference between an open and closed mortgage. Most people have a closed mortgage, which comes with a lower interest rate, but also imposes a penalty for paying it off early. An open mortgage allows you to pay it off anytime without a penalty. But it usually comes with a higher interest rate.

How to break your fixed-rate mortgage

When it comes to getting out of a fixed-rate mortgage, you have a few options. The simplest way is to pay off your remaining loan balance in cash. You can work directly with your current lender to do this if you have the funds.

Most homeowners don’t take that route, of course. They refinance and replace their existing loan with a new one, usually changing lenders. The funds from the new loan pay off the existing one. This comes with fees and closing costs, so, typically, you’ll want to make sure your new interest rate, and terms will save you money over time. If you want to get an estimate of what your new monthly payment could be if you refinance, you can use this mortgage payment calculator from Rocket Mortgage.

Here are the steps to take to refinance your mortgage:

1. Shop for a new lower interest rate loan. Start by comparing lenders and loan options. The goal is to find a rate that makes breaking your current mortgage worthwhile.
2. Calculate your potential savings. Look at how much you’ll save over time versus what you’ll pay in prepayment penalties, closing costs, and fees. You can see current interest rates with Rocket Mortgage here.
3. Apply for the new mortgage. You’ll have to submit financial documents, commit to credit checks and income verification, and more. It’ll be like your original mortgage process.
4. Review loan terms carefully. Make sure your new loan saves you money in monthly payments and long-term costs.
5. Get your home appraised. Lenders typically require an appraisal to confirm your home’s value.
6. Close on the new loan. Once approved, your new mortgage pays off the old one, and you begin making monthly payments on your new one.

Cost to terminate a fixed-rate loan

Penalties on fixed-rate mortgages often require 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. This differential is often considerably higher. It 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.

Here’s a simple example, using the IRD formula:

IRD = Remaining balance × Rate difference × Remaining term

Example: A remaining balance of $300,000 × 2% × 3 years remaining = $18,000

This is only an example, and your details would be unique to your situation, but it shows how quickly mortgage-breaking costs can add up.

Refinancing also comes with other costs, just like your first mortgage did. You’ll have to go through a background and credit check and have to pay appraisal, inspection, and title fees again. These fees can quickly hit four figures.

Pros and cons of breaking a fixed-rate mortgage

Breaking a fixed-rate mortgage comes with potential advantages and disadvantages. Here are a few to consider:

Pros

When the situation favors it, breaking a fixed-rate mortgage can offer some great benefits.

• Potential to save thousands in interest over the life of your loan
• Lower monthly payments
• Better loan terms
• Chance to work with a lender better suited to your needs

Cons

There can be downsides to breaking a fixed-rate mortgage.

• 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

What are your options once you break your fixed-rate mortgage?

Many borrowers elect to go with an adjustable-rate mortgage (ARM). With an ARM, interest rates can change with the market. You may be charged less interest during an introductory period with an ARM (requiring a lower initial monthly payment). If rates go down, you could save money in interest over the life of your loan. However, if interest rates go up, an ARM can become more expensive, with higher monthly payments.

An ARM is not the only choice you have, however. You could refinance to another fixed-rate mortgage with better terms and/or a lower interest rate and monthly payments. Or, if you have the funds available, you could pay off your mortgage and eliminate your monthly payments.

The bottom line: Breaking a fixed-rate mortgage can be expensive

Breaking a fixed-rate mortgage is possible, but it’s not always simple or beneficial. With prepayment penalties, closing costs for refinancing, and the interest rate differential, the upfront expense can be significant.

However, the benefits and long-term savings may outweigh the upfront costs. If conditions are right, you could come away with a lower interest rate, lower monthly payments, terms that suit you better, and thousands in savings. It’s why refinancing is so common.

If you’re ready to refinance or buy a home, you can reach out to Rocket Mortgage and explore your options.