The scary mortgage penalty

Like anything else there is a fine print that comes with your mortgage. A growing mortgage trend for people is looking for the best rate but failing to see what the fine print or the conditions of the mortgage. Why should the fine print matter if you get the best rate and make your payments?

The reality is that most people tend to break their mortgage and move at least once within a 2-4 year period.

The easiest mortgage to get qualified for is a 5 year fixed mortgage. So what exactly happens when you need to break your mortgage? You may need to break your mortgage for many different reasons.  Let’s consider a few that most people never think of when signing the dotted line.

  • There is a special Levy with your strata for major repairs/rain screening, new roof, elevators (These repairs are almost always high ticket repairs, most people if they have equity built up, will refinance to pay for the special assessment) refinancing means you would have to break your current mortgage
  • There is a family change, perhaps you’ve welcomed a new member to your home or your current situation is no longer suitable. Maybe this was unexpected or maybe your place all the sudden seem much smaller than what you remembered. You are looking at selling your place and going into another one.  If you don’t have additional down payment for a new place you would have to sell your home or refinance to obtain some money from your current residence. This would be breaking your mortgage

The same reason why having insurance is so important to protect you for the unexpected, it is also very important to know your options when you are entering into a biggest purchase agreement in your life.  Penalties differ depending on the mortgage product and the lender. Generally the pre payment charge to get out of a variable mortgage is much less as it is calculated based on 3 months interest. However, it’s important to read the fine print, as some of the low interest provider lenders will have alternative ways of calculating the prepayment charges, which could be a surprise to you.

For fixed mortgages, the prepayment charge is calculated using the interest rate differential or the IRD. This would be calculated based on the difference in interest rate, the time remaining on the term and the amount that is left on the mortgage. IRD calculations are almost always higher than variable as you are paying a premium to have stability for the term of the mortgage.

The IRD is where mortgage brokers have a competitive advantage over their bank representative counterparts to more accurately calculate the client’s penalty should the need arise. Major banks will use the posted rates and then apply a discount to the posted rate.

Below is a real scenario of one client.  The name of the lender will be left out for this scenario, but let’s just say it was a major bank.

  • Client took out a 5 year fixed mortgage in July at 3.29% – at a discount of 2.15% off their posted rate of 5.44%
  • Client was planning on porting the mortgage initially, but had to pay it out as they decided to rent for now
  • The bank applied the 2.15% discount to today’s 4 year rate of 4.54%, for a “comparable” rate of 2.39%
  • Bank’s best rate at the time was 3.24%, far higher than the “comparable” rate they used to calculate penalties
  • Based on their balance of $735,796 the IRD penalty was $18,328
  • A 3 month interest penalty would have been $6,051
  • The client paid an extra $12,277 as a result of these posted rates being used

Mortgage brokers have access to lenders who don’t use posted rates, which guarantees that clients don’t get hit with large IRD’s should they need to break their mortgage early.

Know your options and ask the tough questions. Find out the answers before signing on the dotted line.

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About Atrina Kouroshnia

Atrina Kouroshnia is an independent, licensed, mortgage broker in the province of British Columbia. She has a degree in Human Relations & Commerce, and past work experiences in HR & Real Estate Development. She comes to the table with great customer service and problem-solving skills. Her approach to finding the best mortgage solution involves both short and long-term planning, making sure her clients are in a suitable mortgage that is flexible to their needs.