Mortgage penalties have become a hot topic after news stories popped up when families were hit with five digit penalties for breaking a mortgage. In some cases, they were assessed these penalties in order to refinance an adjustable rate mortgage as interest rates in Canada started inching up. In other cases, the mortgage penalty was slapped on people trying to sell their home. Let’s look past the horror stories in the news to get a better understanding of mortgage penalties.
How Mortgage Penalties Are Calculated
Your mortgage penalty is going to be whichever is higher of two values: three months’ interest on your loan or the IRD, the interest rate differential. The interest rate differential is based on what the lender could earn on the money if they loaned it today versus the interest rate they loaned the money to you in the first place.
Not all lenders use the same numbers to calculate the IRD. Some lenders use the interest rate at the time they issued the loan, not the discounted rate you may have received because you had the loan payments automatically debited from your bank account. The remaining duration of your loan may be calculated differently, too. If you’re 3.5 years into a loan, some lenders calculate the IRD as if you were four years in while other lenders would ignore that half year. The only exception to this discussion is the limit set by the Interest Act. If you’re five years or more into the loan, you can only be charged the three months of interest on your loan.
If your interest rate is far above the current mortgage rates, you could be hit with a very high mortgage penalty whether it is based on the IRD or three months interest on your loan. Yet if you do the math, you may find it is worth it to pay the penalty now so you can lock in a lower interest rate.
Who May or May Not Have to Pay a Mortgage Penalty
Based on an analysis of internal lender statistics, even with the five year mortgage being the most common mortgage product in Canada, they still see more than 60% of mortgages refinanced. And many of these people end up paying a mortgage penalty. A penalty of 4.5% on the balance of a four year fixed term loan is commonly seen by Red Deer mortgage brokers.
If your current mortgage contract has a prepayment penalty, you’re not going to be able to change it. However, if you’re shopping for a new home, consult with a Red Deer mortgage broker to find a loan with a lower (or no) prepayment penalty. This is invaluable if you’d like the ability to sell your home at any time without being hit with a massive bill or want the flexibility to pay down the loan faster. Yes, many lenders let you pay a little extra on the mortgage each month, but you could be hit with a mortgage penalty if you pay down too much principle in a given time frame. One way to reduce the mortgage penalty when you refinance the mortgage is to pay it down as much as possible without incurring fees, so that the balance on which the IRD is calculated is decreased.
If you have an adjustable rate mortgage, the pre-payment penalty for the loan is already low, typically about 0.50%. Contact a Red Deer mortgage broker if you’re interested in refinancing your adjustable rate mortgage to a fixed rate mortgage.
Some mortgage lenders won’t charge you a penalty if you are legitimately selling your home so you can move. However, it needs to be a bona fide sale. You cannot sell your home to a family member and continue living there as a workaround to lock in a lower interest rate.
How Politics Affects Your Mortgage Penalty
The Bank of Canada announced in the fall of 2017 that it wasn’t planning on raising interest rates though it had raised rates several times over the course of that year. If interest rates go up, your IRD will go down. Even a slight increase in interest rates will have a far greater impact on the IRD than if you wait a couple months as the maturity date of your Red Deer mortgage gets closer.