The Break‑Even Calculation: Does a Refinance Actually Save You Money?

Contents

1. Refinance Break‑Even: The Core Concept

2. True Cost of Refinancing in Canada

3. Prepayment Penalties: IRD vs. 3 Months’ Interest

4. Province Examples

5. Beyond Penalties: Closing Costs

6. Step‑by‑Step Refinance Playbook

7. Real‑World Case Studies

8. Decision Toolkit

9. FAQ

Refinance Break‑Even: The Core Concept

The core question of when to refinance is answered with a break‑even analysis. It’s not just about finding a lower interest rate. A successful refinance happens when the total savings from your new, lower rate exceed the total costs incurred to break your existing mortgage.

The break‑even point is the specific month when your cumulative savings equal your upfront costs (penalties, fees, etc.). From that month forward, every payment puts real money back in your pocket.

Basic formula:

Break‑Even Point (months) = Total Refinancing Costs ÷ Monthly Savings from New Mortgage

Example: If your current mortgage has 36 months left and your break‑even point is 15 months, you have 21 months of pure savings ahead. If the break‑even point is 40 months, refinancing is not financially viable.

The Full Picture: Calculating the True Cost of Refinancing in Canada

To make an accurate decision, you need true cost transparency. Look beyond the advertised rates and understand every fee involved—especially mortgage prepayment penalties. Only when you have the full picture can you conduct a proper break‑even analysis.

Prepayment Penalties Explained: IRD vs. Three Months’ Interest

When you break a fixed‑rate mortgage before the end of your term, your lender will almost always charge a prepayment penalty. According to the FCAC guide on mortgage prepayment penalties, lenders typically charge the greater of two calculations:

1. Three Months’ Interest: the interest that would accrue on your remaining mortgage balance over a three‑month period at your current rate.
   Formula: (Mortgage Balance × Current Interest Rate) ÷ 12 × 3

2. Interest Rate Differential (IRD): compensates the lender for lost interest because you’re paying back early. In essence, it’s the difference between your current contract rate and the rate the lender could offer today on a new mortgage with a term similar to what’s left on yours.
   Simplified formula: Mortgage Balance × (Current Rate − Lender’s Current Rate for Remaining Term) × (Months Remaining ÷ 12)

Variable‑rate mortgages almost always use the three‑months’ interest penalty, which is a key advantage of that product type.

Province‑by‑Province Prepayment Penalty Notes & Example

While federal regulations mandate disclosure, methods lenders use for IRD calculations can vary. The Financial Consumer Protection Framework Regulations ensure that lenders must provide a penalty calculation upon request.

Scenario assumptions: $500,000 balance, 5.5% fixed, 30 months remaining; lender’s current 2‑year rate: 4.5%.

• Ontario: Many lenders compare your contract rate to their current posted rate for a similar term, then subtract any original discount—often leading to a higher IRD.

  • Three Months’ Interest: ($500,000 × 0.055) ÷ 12 × 3 = $6,875

  • IRD: $500,000 × (0.055 − 0.045) × (30 ÷ 12) = $500,000 × 0.01 × 2.5 = $12,500

  • Penalty Charged: the greater of the two → $12,500

• British Columbia & Alberta: Similar method; specific rates used may differ, but the principle is the same.

Beyond Penalties: Factoring in Closing Costs

• Appraisal Fee: confirms market value ($300–$600)

• Legal Fees: discharge old mortgage & register new one ($1,000–$2,000)

• Discharge/Assignment Fee: remove old lender’s lien ($250–$400)

Add these to your prepayment penalty to get “Total Refinancing Costs” for your break‑even math.

Your Step‑by‑Step Broker‑Backed Refinance Playbook

Step 1: Assess Your Qualification & Readiness

Before you apply, assess your file through a lender’s eyes. Per OSFI underwriting guidance, lenders focus on four areas:

1. Home Equity (LTV): typically ≤ 80% LTV for best pricing.

2. Credit Score: ~680+ to access top rates.

3. Income & Employment: stable, verifiable income.

4. Debt Service Ratios (GDS/TDS): keep within lender limits.

Broker tip: Pay down high‑interest consumer debt to improve TDS. Avoid big purchases or job changes during the process.

Step 2: Choose the Right Refinance Option for Your Goals

Per CMHC guidance:

Step 3: Gather Documents & Get a Broker Review

• Proof of income (pay stubs, T4s, NOA, or business financials)

• Current mortgage statement

• Recent property tax statement

• Home insurance proof

• Government ID

• Assets & liabilities list

Northwood in Action: Real Canadian Refinance Case Studies

Case Study 1: GTA Family Breaks a High‑Rate Mortgage

• Penalty: IRD = $19,600

• Closing Costs: $2,400

• Total Cost: $22,000

• New Monthly Payment: $3,580 (from $4,120)

• Monthly Savings: $540 → Break‑even = $22,000 ÷ $540 = 40.7 months

Advice: break‑even exceeded the 28 months left; we held a renewal rate instead.

Case Study 2: Unlocking Home Equity for Debt Consolidation

• Old Total Payments: $3,510/mo (mortgage + credit cards)

• New Mortgage: $460,000 at 5.1% → $2,705/mo

• Result: one lower payment; freed up $805/mo

Your Decision Toolkit: Calculators & Resources

Interactive Break‑Even Calculator (What You Need)

1. Remaining mortgage balance

2. Current interest rate

3. Estimated new rate

4. Prepayment penalty

5. Closing costs

The output should show new payment, monthly savings, and your break‑even point in months.

Refinance Readiness Checklist

Gather all documents listed above to ensure a fast, seamless process.

Frequently Asked Questions (FAQ)

1) How much equity do I need to refinance my mortgage in Canada?

In general, at least 20% equity (≤ 80% LTV) for a conventional refinance. Different rules may apply for insured mortgages.

2) Will refinancing my mortgage hurt my credit score?

A hard inquiry can cause a small, temporary dip. Over time, improved payment behavior can offset this.

3) Can I refinance if I’m self‑employed?

Yes. Lenders typically request 2–3 years of CRA NOAs and T1 General returns.

4) How is a mortgage renewal different from a refinance?

Renewal: new term with your current lender at maturity (no penalty). Refinance: breaking your current term for a new mortgage (may involve penalties/fees).

5) What is the difference between refinancing and a HELOC?

Refinance replaces your mortgage with a single loan. A HELOC is separate, revolving credit alongside your mortgage.

Disclaimer: Calculations are examples only. Confirm penalty math and eligibility with your lender or broker.