Mortgage Penalties – The true cost of breaking a mortgageMarch 11, 2013
Mortgage penalties can be a complex calculation; leaving you unclear on the true cost of breaking a mortgage. Many times it can be the basis for deciding whether buying, selling, or refinancing a property is worthwhile. It is important to have a clear understanding of what is involved and how your mortgage lender calculates this. The common charge to calculate penalties is called Interest Rate Differential (IRD). These IRD charges compensate lenders for lost interest between what you promised to pay and what the lender can earn today on a mortgage of your size.
The following are some questions you should ask your lender prior to signing a mortgage commitment with regards to penalties:
Is your fixed rate mortgage penalty based on posted, bonded or discounted rates?
If your mortgage is based on posted mortgage rates, it will drastically inflate your penalty, same goes with bonded rates. You should look for the penalty to be based on the discounted rates.
If you break the mortgage and stay with the same lender, will they “forgive” a percentage or the entire penalty?
Your mortgage lender may agree to this, as competition is growing in the mortgage market.
Can I increase the mortgage without a penalty?
This is important if you want the flexibility of refinancing your property to use the equity for renovations or a down payment on another property.
Do you charge Interest Rate Differential penalties on variable rate mortgages as opposed to the standard three-month interest?
This is a highly-unusual, but a few lenders still do this and it can cost you quite a bit if they do.
How long will you honour your Interest Rate Differential quote?
This is relevant if you are trying to discharge a fixed-rate mortgage while rates are dropping. Falling interest rates can increase your IRD penalty.
The Financial Consumer Agency of Canada encourages clarity with mortgage penalties, and by early 2013 it is imposing that banks provide consumers with annual information to calculate penalties, provide written penalty statements upon request with clear calculation explanantions, and to have access to exact prepayment penalty quotes. Implementing these initiatives will certainly help add clarity to mortgage penalty implications.