Homeowners across British Columbia keep hearing about ultra-low mortgage rates and in pricey markets like Vancouver, the interest rate can be very important to buyers. But if you shop on rate alone, then you may not consider other important factors, like how your mortgage lender calculates the prepayment penalty for exiting your mortgage early. Although these rates seem the same on paper, they are actually quite different when it comes to the penalty calculation.
For a variable-rate mortgage, the penalty is generally three months of interest at your current rate. Although, there are variable rates that come with much higher penalties ranging between two and three percent of outstanding loan balance. For fixed-rate mortgages, the lender typically charges penalties based on the interest rate differential (or IRD). This is based on the difference in interest rate between your current interest rate and what the lender could earn by relending funds for your remaining mortgage term. IRD almost always results in a higher penalty than you’d have with a variable rate, because you are paying a premium in exchange for the stability of a fixed-rate mortgage.
Mortgage brokers often bring a competitive advantage over their bank representative counterparts because they can more accurately calculate the client’s penalty should the need arise (online calculators are often inaccurate). Major banks and credit unions will use the posted rates and then apply a discount to the posted rate making the gap larger and therefore resulting in a higher IRD. Mortgage brokers have access to lenders who don’t use these artificial posted rates, which means their clients won’t get hit with huge penalties should they need to break their mortgage early.
Below is a real scenario of one client in Vancouver who had a mortgage with a major bank and decided to move :
- Client took out a 5 year fixed mortgage at 3.29%, a discount of 2.15% off the lender’s posted rate of 5.44%
- At the time that the client was breaking the mortgage, the bank applied the 2.15% discount to their 4 year posted rate which was 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 the client’s loan balance of $735,796, the IRD penalty was $18,328
- A 3-month interest penalty (based on a variable-rate mortgage) would have been $6,051
- The client paid an extra $12,277 as a result of the posted rates the lender used
Because greater Vancouver is experiencing such a hot market, some people are going higher on their budget hoping they will cut back on rates and in case they need to break that mortgage (which can happen for any reason, especially with young couples) they really should consider the potential penalties.
Porting your mortgage is a nice option, but that’s assuming you can get a home within the allowed time frame (usually 90 days), which may or may not happen depending on market, inventory and your overall needs.
A major bank or credit union that uses posted rates and discounts off the posted rate would not be comparable to a broker lender that does not use posted rates for penalty calculation. Working with an independent mortgage broker can help you understand these nuances and choose the most suitable mortgage for your needs, factoring in not just interest rate but also prepayment penalties, portability and other considerations.