Mortgage Penalties

Sometimes we need to break our mortgage contract early. We need to refinance, sell our homes or want to take advantage of a better interest rate. If you are considering breaking your mortgage contract before it is up for renewal, you will have to pay mortgage penalties.

What are mortgage penalties?

Mortgage penalties are a small amount you will have to pay if you wish to get out of your contract before it reaches maturity. These penalties are in place to protect the lender and ensure they recoup some of the funds they’re losing when you’re no longer paying them interest.

Penalties can also occur if you wish to pay more than what is allotted for your prepayment privileges. To avoid paying this type of penalty ensure that you are not exceeding the amount of your prepayment privilege.

How are mortgage penalties calculated?

The type of mortgage you have will determine the amount of your penalty. For example, if you have a variable rate mortgage, your penalty will be three months interest. On the other hand, if you have a fixed rate mortgage your penalty will be the larger of the following:

  • Three months interest
  • OR

  • The interest rate differential

There are other factors involved in calculating mortgage penalties:

  • The term of your mortgage contract
  • How much time has lapsed since you signed your contract

What is the interest rate differential?

The interest rate differential (IRD) is the charge that applies if you pay off your mortgage in its entirety before it reaches its maturity date. The IRD also applies if you pay down the principal beyond the amount that is allowed as part of your prepayment privileges.

The IRD is the difference between the interest payable on your existing mortgage and that owed on your new/replacement mortgage. Variable rate mortgages do not have interest rate differentials, only their fixed rate counterparts do.

Is it worth it to break my mortgage contract early?

This will depend on your financial situation. It’s best to sit down with a mortgage broker to figure out if breaking your mortgage early is the right thing to do. It may not be ideal for you to pay the penalty, or it could save you money in the long run. Additionally, you should talk to your broker because not all lenders prohibit breaking your mortgage early unless it’s for the sole purpose of selling your home and purchasing a new one. Before you decide if breaking your mortgage contract early is the right move, talk to your broker just to be on the safe side.

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