Rare-earth-based permanent magnets (PMs) have a vital role in numerous sustainable energy systems, such as electrical machines (EMs). However, their production can greatly harm the environment and their supply chain monopoly presents economic threats. Alternative materials are emerging, but the use of rare-earth PMs remains dominant due to their exceptional performance. Damage to magnet structure can cause loss of performance and efficiency, and propagation of cracks in PMs can result in breaking. In this context, prolonging the service life of PMs and ensuring that they remain damage-free and suitable for re-use is important both for sustainability reasons and cost management. This paper presents a new harmonic content diagnosis and motor performance analysis caused by various magnet structure defects or faults, such as cracked or broken magnets. The proposed method is used for modeling the successive physical failure of the magnet structure in the form of crack formation, crack growth, and magnet breakage. A surface-mounted permanent magnet synchronous motor (PMSM) is studied using simulation in Ansys Maxwell software (Version 2023), and different cracks and PM faults are modeled using the two-dimensional finite element method (FEM). The frequency domain simulation results demonstrate the influence of magnet cracks and their propagation on EM performance measures, such as stator current, distribution of magnetic flux density, back EMF, flux linkage, losses, and efficiency. The results show strong potential for application in health monitoring systems, which could be used to reduce the occurrence of in-service failures, thus reducing the usage of rare-earth magnet materials as well as cost.