When it comes to mortgages, rates aren’t the only thing that matters. With approximately 6 out of 10 mortgages being broken within the first 3 years, it is important to understand the reality of mortgage penalties.
At the end of the day, a mortgage is a contract between you (the homeowner) and the lender. As such, there are penalties involved if the contract is broken; this usually happens when a home is sold or re-financed. In Canada approximately 6 out of 10 mortgages are broken within 3 years. Here’s some information to help you understand these penalties and how they could impact your decision.
How Mortgage Penalties Are Calculated
The Penalty for breaking a mortgage is calculated in two different ways: an Interest Rate Differential (IRD) calculation, or three months interest. Typically the Bank will charge you the higher of the two.
Interest Rate Differential (IRD):
Banks calculate IRD Penalty differently. Typically the Big 5 banks formula for IRD will result in a higher penalty then other mortgage lenders. Typically the IRD is based on the amount remaining on the loan and the difference between the original mortgage interest rate you agreed to and the current interest rate lenders charge today.
Ideally, you will want to be aware of what your IRD penalty would be before you decide to break your mortgage, as it is not always the most viable option.
IRD Penalties can vary greatly. Let’s assume you have a balance of $200,000 on your mortgage, an annual interest rate of 6%, with 36 months remaining in your 5-year term. Let’s also say that the lender’s current rate is 4%. This would mean an IRD penalty of approximately $12,000 if you break the contract.
Three Months Difference:
In some cases, the penalty for breaking your mortgage early is simply equivalent to three months of interest. Using the same example as above – a balance of $200,000 on your mortgage, with an annual interest rate of 6% – then three months interest would be a $3,000 penalty. Typically these types of penalties are applied for variable-rate mortgages.
Paying The Penalty
Whenever possible, wait out your current mortgage term before making a change to your mortgage; this is the best way to avoid paying penalties. If you can’t wait, remember that online calculators can be great tools for estimates, but it’s always best to contact us directly to discuss your mortgage terms and potential penalty calculations.