Broker vs. Bank / Documents / Lenders / Mortgage Renewal / Pre-Payment / Rates & Terms / Refinance / Rental Properties / Variable Interest Rates

Mortgage Payout Penalties

What you need to know

You may not hear about a payout penalty until you want to break your mortgage term early, then you could be surprised by the figure you are quoted by your existing lender. Be prepared by understanding how your penalty is calculated before you make a decision to pay out your mortgage term before it’s over.

Payout penalties apply to any type of closed mortgage term, both variable and fixed rates. If you have an open mortgage term or a home equity line of credit (HELOC), you will not be subject to paying a payout penalty though there may be some other minor administration charges. Due to less restriction’s, open terms tend to come with higher interest rates and HELOC interest compounds monthly versus semi-annually with amortized mortgages.

If you have a closed mortgage term for 6 months to 10 years and choose to break the term early, you could be charged the GREATER of ‘three months interest’ or the ‘interest rate differential’. The cost which is applicable to you is determined by comparing the current interest rate you are paying and what rate your lender could get if they had to re-lend out your mortgage funds today. While the below calculations will give you an idea of how the payout penalty is calculated, you should get a payout penalty quote from your current lender in writing before committing to changing your existing term.

At the same time, ask if there is any way you could reduce the payout penalty by utilizing the pre-payment options before the mortgage is paid out.

Three Months Interest

You will likely be charged 3 months simple interest if the interest rate on your existing mortgage is lower than what your lender can get today for a similar term comparable to the time remaining in your term. For instance, if there is 2 years left in your mortgage term, your rate is compared to today’s 2-year term rate.

Here is how to do a rough payout penalty calculation based on three months interest charged;

Current Mortgage Details

Balance: $325,000

Interest Rate: 3.50%

 

The calculation is simply:

Balance

X Interest Rate

/ 365 days

X 90

= approx. payout penalty

 

Using the current mortgage details above;

$325,000

X 3.50%

/ 365 days

X 90 days

= $2804.79 Three Months Interest

This option is usually the default for calculating the potential payout penalty for variable rate mortgage terms. Though whatever term type you presently have, I must emphasize the above is a simplified version of the potential payout penalty calculation and should not be relied on in lieu of contacting your existing mortgage lender for an exact amount.

 

Interest Rate Differential

This calculation will likely be used if your existing mortgage rate is higher than the interest rate available today for a comparable term. If you have 2 years left on your mortgage term, your rate is compared to today’s 2-year term rate. Your lender will use the below calculation to ensure they recover the interest lost by allowing you out of your term early and having to lend the same funds out at a lower rate than you were paying. Here it is using an example;

Current Mortgage Details

Balance: $325,000

Interest Rate: 3.50%

Remaining Term: 2 years (initially 5 years)

Compared to best rate of 2.04%* available today for a 2-year term

Difference between interest rates: 1.46% (3.50%-2.04%)

 

The calculation is simply:

Balance

X difference between interest rates

/ 12

X Remaining Term in months

= Approx. payout penalty

 

Using the current mortgage details above;

$350,000

X 1.46%

/ 12

X 24 Months

= $10,220

 

There is an unknown factor involved with trying to calculate the interest rate differential; in that we do not know what interest rate your existing lender will use to compare to the mortgage rate you presently have. It could be the best rate available, the bond rate or their posted rate with a discount. That is why it is important to contact your current lender to get a more accurate payout penalty quote.

Your initial mortgage commitment documents should contain a clause that details what your payout penalty will be in the event you break your term early. Do be aware some lenders have an extra charge should you break the term early. Those lenders may be the “alternate” lenders or lenders offering super low rates. Also be advised if you took a “cash back” mortgage, you will have to pay a pro-rated amount back dependent on how far you are into your term.

*Interest rate is based on best rate available on August 16th, 2015. O.A.C. E & OE, rates subject to change without notice.

If you have mortgage questions, contact the Mortgagegirl at 780.433.8412 or email info@mortgagegirl.ca. Stay in the loop by following on Twitter @Mortgagegirlca.

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