There’s nothing worse than breaking your mortgage, by way of sale or refinance, and finding out that you have a massive penalty. It’s the worst.
Mortgage penalties are brutal, period. Nobody likes them, but they’re very real and cause a lot of financial headaches for people. Standard penalties for a fixed rate mortgage are equal to the greater of 3 months interest or the interest rate differential (IRD). Conversely, variable rate mortgage penalties should never exceed 3 months interest, which is nominal (we at SPIN tend to like variable rates).
We will focus solely on fixed rate penalty calculations as they’re the culprit. The way lenders calculate their IRD penalty varies wildly and has been a highly controversial issue in Canadian mortgage lending. Let’s look at a simple example to differentiate between two lenders.
Example: Let’s assume you took a 5 yr fixed rate mortgage one year ago with Bank A at 3.09% and Bank B at 3.09%. You have 4 years left in the term and still owe 400K. You’ve sold your place and are going travelling for a year (and that’s awesome, we’d do it too!). HOLD ON! What’s your penalty going to be? Let’s assume rates have dropped, which they have since then. Basically, lenders are going to look at 4 year money (the term remaining) and calculate the interest rate differential. If this amount exceeds 3 months interest, then you’ll have to pay it. In both cases, the 3 month interest penalty is 3,090. The IRD, however, depends on the methodology used to calculate it. Specifically, Bank A uses the true contract rate and Bank B uses the posted rate.
Bank A penalty (contract rate method) – $8,800
Bank B penalty (posted rate method) – $41,600 (Cha Ching!)
There’s really not much to say about this. Clearly, you can understand why it’s highly scrutinized in the mortgage business and why it’s imperative that you understand the methodology employed by your lender of choice when calculating an IRD penalty.
Curious about which lenders are the biggest offenders? Contact us. Happy to chat about how ridiculous some of them are and steer you in the right direction.
