Mortgage Penalties: How the same rate can cost you $7k more

Without question, mortgage penalties can end up being the most costly element of a mortgage.  Penalty calculations vary between lenders & is exactly why you need to shop around & do your due diligence (or speak to me!).

 

Fixed rate penalties are the greater of:

— 3 months’ interest  [(mortgage balance * interest rate / 12) * 3], or
— the Interest Rate Differential (IRD): this calculation compares your interest rate to the current rate for the remaining term of your mortgage.  ex: 4 years into a 5 year term, that rate would be based on the lender’s 1 year fixed rate.
**there are certain “no frills” or “low rate” products which are the greater of those 2 calculations OR 2.75% – 3% of the mortgage balance.

 

For this comparison, we’re going to look at a few examples of penalties under the following criteria:

-$400k mortgage at 2.69% 5 year fixed, 25 year amortization
-2.05% discount received off the bank’s posted rate of 4.74%
-a current 2 year posted rate of 4% when the mortgage is broken
-breaking the mortgage in year 3 with $364,871 remaining

 

Big Bank (Scotia, TD, BMO, RBC, CIBC):

$5,400

-The banks’ calculations factor in the discount you received off the posted rate when the mortgage was setup.  In this case, that discount is 2.05%, so the comparison rate is going to be 1.95% (4%-1.05%)

 

Mononline Lender (First National, Street Capital, MCAP, etc):

$2,690

-monolines do not have posted rates.  Comparing your rate to their current discounted rate makes a big difference on penalty.

 

“No Frills”or “Low Rate” product:

$10,946

-These highly restrictive, low rate, products are currently offered by a number of monolines (Canadiana, RMG, DLC) & have different names depending on the lender.  The rate is lower than their standard fixed rates, however the penalty is the greater of 3 months’ interest, IRD OR 2.75% – 3% of the balance.  You can bank on the penalty being the later of those 3 calculations.

 

 

Mortgage penalties vary, a lot.  This is easily the most overlooked feature of a mortgage & can easily end up being something people regret not looking into further.  On avg, in Canada, most borrowers break their 5 year mortgage before the 4th year.  A lot can happen, especially if this is your first purchase.

When you weigh your options, you need to compare the savings on rate to the potential difference in penalty.  On that above example, the difference between 2.74% & 2.69% is $10 / month, which is generally less than what most people would assume.  Is it worth saving $10 / month for the next 5 years but risking a penalty that could be $7k greater?

Ask the right questions.  You’ll be glad you did!

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