When mortgage interest rates rise, it is generally not something we like to celebrate. (Especially when they keep on rising).
For Canadians trying to get into the market, the rising interest rates can create hardships and further exaggerate the problem of affordability. But for some existing homeowners, rising interest rates could actually present a benefit.
Most of the borrowers out there are in closed mortgages. And if they want to pay out their mortgage before the end of the term, we will have to pay the lender a penalty. Under most conventional mortgage contracts, these penalties are called an ”Interest Differential”.
The calculation of this penalty can be quite complicated. However, despite the complexities of the calculation, we can anticipate how the penalty will rise and fall with the rates. During the time of very low interest rates there were borrowers who locked their mortgage in at a higher rate. These borrowers had to pay some staggeringly high penalties to get out of their contracts.
The opposite is true when interest rates are on the rise, for example:
If someone bought a house 3 years ago under a 5-year mortgage term and then wants to sell their home. They will be forced to pay out their mortgage before their term is up. This in turn, will be subjected to a penalty. The same is true if the borrower wants to refinance their mortgage before the end of their term.
But because of how the Interest Differential is calculated, as interest rates go up, the amount of the penalty will go down – often, quite substantially even with only minor changes to the interest rate.
Borrowers who need to sell or refinance their homes before the end of their terms are seeing the bright side of rising interest rates. And the cost of getting out of their mortgage just got a lot cheaper.
So you see, rising interest rates don’t have to mean all bad news for borrowers.