Some mortgages may have a predetermined fee built into the agreement for breaking it, but most commonly the fee is calculated based on either; three months’ of interest payments, or the interest rate differential (IRD). IRD is the difference between the original interest rate and the current interest rate on the balance for the remainder of the term. The penalty is usually the higher of the two calculations for a fixed rate mortgage and three months interest for a variable rate mortgage.
A big question that you need to answer before you attempt to calculate your penalty on a fixed rate mortgage is ‘Did you get a discount on your rate’. Most big banks will offer discounts on their posted rate. For example the posted 5yr fixed rate is 4.64%, but the bank offered a discount of 2%, making the rate charged 2.64%. Now when they calculate the IRD they will take this discount into consideration. So if there was 2 years left on your mortgage they would use the current posted 2 year rate less the 2% discount. For this example the 2 year posted rate is 2.84%. Therefore the IRD will be the difference between the current rate of 2.84% - 2% discount = 0.84% and the original rate of 2.64% which equals 1.8%. If the mortgage was done through a monoline lender (via a broker) and the rate was 2.9% for 5 years and the current posted rate is 2.84%. The IRD would use 2.9% - 2.84% = 0.24%. This makes an enormous difference in your penalty. This is one of the reasons we, as brokers and agents, cringe when a client says ‘but the bank is offering me…can you beat that rate?’ Yes rate is important but there are more things to consider when looking for a mortgage other than rate.
Let’s face it; no one enters a 5 year mortgage contract saying ‘I will break this year 3’. But statistics show…life happens. Whether it be a new roof, your kid’s education, illness, job change, things happen.
Not only do we put clients in the best rate/product at purchase, we also review and protect our clients on the back end, for the ‘what if’ situations. Please contact us to discuss your needs.