Mortgage penalties you might ask? Well a frequent topic of conversation with many of my clients, new or existing will inevitably result in talking about the dreaded mortgage penalty. If you are in a closed mortgage, you may have been burned in the past by not even knowing about an imminent mortgage penalty, while others are just not educated on how these penalties are calculated, and why.
If you are looking to get out of your mortgage early, whether to capitalize on recent low interest rates or the possibility of listing your property to invest in another, a mortgage penalty will most likely apply. Unfortunately, these penalties are not usually negotiable. I say 'usually' as there have been cases where the lender will waive the penalty, if for instance, the mortgagor purchases a new property within a certain time frame of selling their existing.
Penalty clauses may have been explained to you, or not. Advising my clients on how penalties work is so important to mitigate any surprises down the road. It's always comforting to know any of the hidden nuances that can present themselves when least expected. Of course, most lenders usually include the penalty clauses written in extremely small font on a back page of the mortgage document somewhere, but it's there.
If you are currently in a variable rate mortgage, your penalty will always be calculated by using 3 months of interest on your mortgage balance. Here is an example:
Mortgage Balance - $200,000.00
Interest Rate - 5.50%
Remainder of Term - 4 years and 2 months (4.16 years)
200,000.00(balance) x 5.50(interest rate) / 4 = $2,750.00
If you were to break this mortgage, you would have to pay the lender $2,750.00. This could make sense if interest rates are significantly lower as you'd most likely save that amount and more by switching products. Ask me for a free consultation on your current situation, I'd be happy to advise you on what makes sense.
If you are currently in a fixed rate mortgage, your penalty will be calculated by using 3 months of interest or the Interest Rate Differential (IRD), whichever is greater. The IRD is the difference between the interest you would have paid over the balance of the term of your mortgage and the interest the lender can earn if reinvested the money you prepay in another mortgage. Huh? I'm totally with you on that one!
The IRD is a more complex calculation as it takes the difference between your interest rate, the outstanding term and the current interest rate for the length of time remaining on your mortgage. Here is an example:
Mortgage Balance - $200,000.00
Original Interest Rate - 5.50%
Current Interest Rate - 4.45%
Remainder of Term - 4 years and 2 months or (4.16 years)
200,000.00(balance) x [5.50(original interest rate) - 4.45(current interest rate)] x 0.0416(remainder of term) = $8,736.00
***Take note that the current lender you have your mortgage with will be able to tell you precisely what your penalty is, they all calculate the IRD a bit different.
You may have a portability clause tied to your mortgage, in which case a mortgage penalty would not be charged. This is a fantastic option if you are thinking about the big move to a new property. This option allows you to transfer your interest rate, existing terms and conditions to your new home, subject to a credit review and property appraisal. You may also qualify for a larger mortgage amount if the property has a higher price tag than your existing. You would need to pay the legal fees for this transaction, but this is considerably less than a mortgage penalty.
In closing, a few helpful tips to avoid the mortgage penalty would be to evaluate the current property you are in and decide on a timeline. If you can't see yourself in the same property for 5 more years, I'd look at getting a shorter mortgage term or consider an open mortgage, they do not carry mortgage penalties.
As always, I encourage you to contact me if you have any questions with your current mortgage or are looking for one. Please find me on facebook at Jason Nesseth | Mortgage Specialist | British Columbia and on twitter @jasonmortgages.
"Working with you for the life of your mortgage!"
Jason Nesseth with TMG The Mortgage Group Canada Inc. If you have any questions or comments about this blog, please feel free to call Jason at 604.375.7375, email jason.n@mortgagegroup.com or visit his website at jasonnesseth.com