Payout Penalties: What are they? How are they calculated?

I often get calls asking to refinance an Edmonton mortgage to payout some debt, which is always a great idea, but one thing has to be determined first. What is your penalty going to look like if you leave your current lender?

Not all mortgages are equal nor are the banks or lenders you may deal with. When it comes to variable rate mortgages, penalties are always the same, they are typically 3 months interest portion. When it comes to breaking a fixed rate mortgage, penalties are always calculated on “the greater of three months interest or the interest rate differential (IRD). What you need to be completely aware of is how lenders each calculate those penalties. Most of the Big 5 Banks calculate their penalties based on the Posted Rate rather than our Mono Line Lenders calculate the penalty based on the actual contract rate you have.

Let’s start by assuming you have a mortgage balance of $250,000 on a 5 year term mortgage with a fixed rate of 2.59%. Three years have passed by and you have 2 years remaining from the 5 year term. Current interest rates are the same as they were when you first got the mortgage.

Let’s first calculate the cost of three months interest penalty:

250,000 X .0259 divided by 365 days X 90 days = $1,596.58

Calculating IRD (Interest Rate Differential) is where things get complicated. It is the difference between the interest rate on the mortgage and the current standard, discounted or posted interest rate, for a mortgage term similar to your remaining time on your current mortgage term.

Most people do not realize that how lenders calculate these penalties is very different and amounts to a very different penalty amount. Lenders can choose to calculate their penalties in the following way:

The Standard Rate IRD Penalty: When calculating a penalty using this method, the lenders use the difference between your contract rate and their current discounted rate that matches the remaining term they have left.

The Discounted Rate IRD Penalty: This is where the lender takes your contract rate and compares it to the Posted Rate that most closely matches your remaining term MINUS the original discount you got on the 5 year term. This leads to a higher penalty.

The Posted Rate IRD Penalty: This calculation is where the lender uses the 5 year posted rate when they offered you the mortgage.

The interest rate differential amount is the difference between the interest on the current balance owing for the remainder of the term at the posted rate at the time you took out the mortgage and interest on the current balance owing for the remainder of the term, using a comparable posted rate.

I don’t think that the majority of mortgage borrowers have any idea that there are significant differences in the way fixed rate mortgage penalties are calculated and banks bank on that lack of awareness and use it to their advantage. This all boils down to reading and understanding the fine print. These penalties can have more of an affect than simply looking at the interest rate between one lender and another. Typically, if one bank has 2.59% and another 2.54 most consumers would lean to the 2.54 however if they break the mortgage contract, the small savings between interest rates is minimal as compared to the IRD costs.

For further information, contact Eva at (780) 244-0505 or by email at eva@mortgagetailors.com

Leave a Reply

Your email address will not be published. Required fields are marked *