The Ins and Outs of Mortgage Penalties

The historically low interest rates that Canada is experiencing right now has spurred many people to consider refinancing their mortgage in order to take advantage of these low rates.  In most instances, refinancing can save you thousands of dollars in interest. One of the primary considerations when looking at refinancing is your penalty.  All Lending Institutions charge Borrowers a penalty to get out of their mortgage before the term is up.  However, not all Lenders calculate that penalty in the same way.  

There are typically two methods for calculating a mortgage penalty, 3 Months Interest Penalty, and Interest Rate Differential (IRD).  The 3 Month Interest Penalty is just that, 3 months worth of interest.  For example, if you have $250,000 outstanding on your mortgage at a rate of 5.75% you would pay $3,593.73 as your penalty.  This penalty can be rolled into your new mortgage.  

$250,000 Outstanding Balance x (5.75%Interest Rate/12 months per year) x 3 Months =

250,000 x (.00479) x 3 =

$3,593.75

The second method for calculating penalties is the Interest Rate Differential (IRD).  This essentially is the difference between the interest that you are paying and the rate at which they are currently lending money.  Using the same example as above with $250,000 outstanding on your mortgage at a rate of 5.75%, 2 years left in your term, and a current interest rate of 3.95%,  you would pay $9,000. This can also be rolled into your mortgage.

250,000 x (5.75% – 3.95%/12) x 24 (# of months left in your term) =

250,000 x (1.8%/12) x 24 =

$9,000.00

Although this may seem like a lot of money, you would get this penalty back in a couple years, while paying less in interest and having overall lower monthly payments.  Just think about enjoying a lower monthly payment AND saving thousands in interest. Most Lenders will charge the higher of the two methods.  Finding out the penalty you are facing to discharge your mortgage is your first step to analyzing whether it would be beneficial to refinance to a lower rate.  Once you determine your penalty, a Mortgage Broker can help you decide whether refinancing is right for you.