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Brandon Lowi

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How much?!?! Mortgage pre-payment penalties explained.

10/9/2014

If you were hoping the Canadian government had introduced a new law standardizing mortgage penalties, you’ll be sad to learn no changes yet. Rumours swirl that something has to or will be done in regards to this issues. But, until that time we’re stuck with what we have. So, it is in your best interest to understand how pre-payment penalties work.

 

You’ll be shocked to know that the average Canadian breaks their mortgages every 3.5 years, and the most common term people take is 5 years. It’s easy to see why understanding mortgage penalties can end up saving you thousands. Of course, there are some simple strategies to avoid a penalty:

 

  1. Wait until your maturity date to refinance, buy and sell, or switch lenders.
  2. Porting – Most mortgages include a portability features that essentially allows you to transfer your mortgage to a new property.
  3. Early Renewal – Some lenders will allow you to renew up to 6 months early without penalty.

 

However, when these situations don’t line up, or aren’t available, clients are forced to pay what sometimes can be a massive mortgage penalty. For example, if you started a new mortgage exactly one year ago when rates were around 2.99% for a 5 year fixed closed term and you wanted to pay out your loan in full, here are some numbers to consider:

 

  1. Scotiabank- $9,860.00
  2. BMO - $4,640.00
  3. MCAP - $2,167.00

 

These calculations can be done at home if you want to test your individual mortgage. Each financial institution is now required to disclose a pre-payment calculator or formula on their websites to allow Canadians to calculate their own penalty.

 

So, you’re probably wondering how these penalties are calculated? Well it’s a method of two formulas, Interest Rate Differential (IRD), or 3 Months Interest. With a Variable Rate Mortgage, it is always 3 months interest. If you have a fixed mortgage, it’s the IRD or 3-Months Interest and it always depends on which is greater. I should note that “No Frills” Mortgages, or super low rate mortgages can sometimes have completely different ways of calculating a penalty. Beware of what you’re signing!

 

IRD – What it means……..

 

Interest rate differential is the difference of your current mortgage rate and what the lender could offer in today’s current market. For example, if you have 4 years left on your mortgage, the lender will compare their rate to what their current 4-year rate is.

 

This calculation differs between lenders in regards to how they determine what rates to compare. Banks have posted and discounted rates. If you review any mortgage documents from the Big 6 Banks, it shows you the discount offered from the posted rate.

 

Right now, Scotabank has a 5 year rate of 4.79%, however, you could walk in there today and get 3.09% on the same 5 year term. But, when they go to calculate the penalty, don’t think they won’t consider the original discount.  This is huge when picking your lender, especially if you know you may need to break your mortgage.

 

Other lenders, especially those available through the broker channel, compare rates at face value. Meaning, the discount rate is compared to the discount rate. That is what you saw MCAP (above) with the lowest mortgage penalty.

 

In essence, when selecting a mortgage lender, be sure to consider all your options.  It could end up saving you thousands.

 

 

Brandon Lowi

Mortgage Agent in Kingston, Ontario, License #M13000201

 

 

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