Posted by John Doe
Understanding mortgage penalties can help you to reduce the potential cost of homeownership and ensure you’re abiding by the rules set by your lender. These rules can sometimes be complicated, and so you may be required to review your specific financing agreement with your lender to determine the penalties specific to you.
To help you guide you, our team at Mortgages Mortgages is highlighting what you need to know about mortgage penalties in Canada in this new post.
What are mortgage penalties?
Mortgage penalties are the amount of money you will pay to your lender if you wish to break your mortgage contract early. Lenders in Canada place mortgage penalties into a contract to protect their business against losses in interest payments that you would have made had your contract continued.
How much will I pay?
To prepay your mortgage and to void a mortgage contract will cost a different amount depending on the type of mortgage contract you have with your lender. However, the general rule is that the borrower must pay the lender three months of interest on the remaining balance of the mortgage.
So, say you have $300,000 left on your mortgage with an interest rate of 5.49%. 5.49% of $300,000 is $16,470, divided by 12 months is $1,372.50, and multiplied by the three-month penalty is $4,117.50. Your three-month mortgage penalty will thus be $4,117.50 in this scenario.
What is the interest rate differential?
Another type of penalty placed within fixed-rate mortgage contracts is the interest rate differential. Within this calculation, the lender compares the difference between the interest rate for a similar lending contract in the current market and the interest rate when they originated the mortgage contract. Calculating your current interest rate differential (IRD) penalty can be complicated.
There is no standard approach to calculating the IRD, and some lenders will include the discount you might have received when negotiating your contract.
So, if the posted rate at the time was 3.99% and you received a discount to get a rate of 1.99%, then the lender may calculate the interest based on the 3.99% posted lending rate and not the rate you received. Effectively, you may have to pay back your discount if you break your mortgage contract.
Generally, the process for determining the interest rate differential includes the following:
- Your current mortgage principal ($300,000).
- Your original mortgage rate (5.49%).
- The remaining length in the contract (36 months).
- The lender’s current rate for a similar term (3.89%).
You subtract the current mortgage rate from your original mortgage rate: 5.49% – 3.89% = 1.60%. You then multiply the difference in interest rates by the remaining mortgage principal, 1.60% x $300,000, and divide this number by 12 months: $400. Then, multiply this number by the remaining months of your contract. So, 36 months left on your term multiplied by $400 means a $14,400 penalty.
Tips for Avoiding High Penalties
So, now you know a little more about the calculations that financial institutions in Canada use to arrive at mortgage penalties, it’s imperative to take steps to avoid higher costs. There are several steps you can take to reduce your mortgage penalties. These include:
Port Your Mortgage
In some cases, your lender will allow you to port your existing mortgage at its current rate and current balance to a new property. Therefore, if you’re considering selling your current property and buying a new one, you might port your mortgage to avoid penalties from your existing contract.
Speak with your lender as early as possible in the new property purchase phase to determine the viability of porting your current contract.
Call Your Lender to Get the Details
Before breaking your existing contract and accepting any mortgage penalties, call your lender directly and ask them about the penalty if you were to break your current contract today.
They can provide you with the final cost, which may also include a discharge fee. You can then decide whether it makes financial sense to move forward in breaking the contract.
Capitalize on Prepayments
You may be able to significantly reduce your costs by capitalizing on the allowed prepayments within your mortgage contract. This process requires you to access your current contract and review the rules regarding prepayments carefully.
Most institutions will allow you to make prepayments up to 20% of your mortgage balance each year. Your agreement will likely also allow you to increase your monthly payments up to 20% annually. Utilizing annual lump sums and monthly increase options can help you consolidate any penalty by thousands of dollars.
Try to Refinance With Your Current Lender
It’s not very common, but you may be able to avoid a penalty by refinancing with your current lender. Depending on your history with the lender and the potential lending programs the lender offers, they may present a new mortgage without any penalties.
Ask about your refinancing options before you decide to pay. As well, make sure you have considered the total cost of refinancing, and balance it against your payment penalties. Your lender should be able to provide you with a clear breakdown of the difference between the two sums.
Analyze All Contracts Carefully
While you might not be able to change your current contract now, you should evaluate any future contracts you sign carefully for the penalties you might face for breaking the agreement. And remember: you can call your financial institution directly to ascertain how they calculate penalties before you sign the contract.
Having this information as a foundation when going into a contract will ensure you’re prepared to handle any payment obligations.
Our team at Mortgages Mortgages has decades of experience helping clients find the best rates for their property purchases. We can help you analyze your current mortgage contract and determine the best way to proceed and save money in the long term. To learn more about your mortgage options, call us today at 866-307-0747 or contact us directly here.