If you have a fixed rate mortgage, you may be able to get a better interest rate or even acquire additional funding by breaking your mortgage. Unfortunately, you will have to go through your disgruntled lender and the subsequent prepayment penalty. The penalty protects lenders against losses and usually represents the profit the lender was going to make on your mortgage had you not broken it early.
When deciding if it is worthwhile to break a mortgage, it is important that you first determine if the prepayment penalty is less than the total amount you will save in a new mortgage agreement. Moreover, you will need to inform yourself on the prepayment penalty, as it can be one of the most perplexing aspects of a mortgage agreement.
In addition, be mindful that there are currently no standard formulas for penalties nor is there any federal legislation or oversight on the immediate horizon.
Working with a Mortgage Broker will provide you with access to some tricks to reduce these penalties and keep your mortgage lender in check when they are calculating penalties. On average we are able to save our clients 17% of their quoted penalty.
- The most common penalty from lending institutions for breaking a mortgage contract amounts to the greater of three months interest penalty or the Interest Rate Differential (IRD).
- Therefore the larger of these two figures will be your penalty.
- The three month interest penalty is calculated by taking your current mortgage balance multiplying it by your current interest rate and multiplying that by 3.
- (Present Mortgage balance x Current Interest rate) x 3 = Three Month Interest Penalty
- The IRD is the difference between the interest rate on your mortgage compared to the rate at which the lender can relend the money.
For example, if you owe $175,000 at 3.39% and have 2 years left on your mortgage the lender will first identify the prevailing 2 year rate (if today’s rate is at 2.99%), then the lender will charge you by working out the difference between those rates – 0.40% in this case.
The lender will then take this difference of 0.40% and multiply that by your mortgage balance 175,000 and the time remaining on your mortgage which is stated as the number of months remaining on your mortgage divided by 12. Therefore –
(3.39% – 2.99%) x $175,000 x (24/12) = $1400
Unfortunately, the above example represents an oversimplification of the problem. Due to lack of regulation, lenders don’t always use the most common penalty calculation methods. They more typically devise more complicated ways to calculate your interest differential, often calculating this penalty to their advantage. Lenders can use different penalties for each type of mortgage they offer and they change them regularly, so don’t assume your penalties are the same as when you got your mortgage if you have already renewed.
The good news is that there are supposed to be Federal Government guidelines arriving that will standardize the explanation of the Interest Rate Differential prepayment penalty. This should make it easier for borrowers to understand what they’re signing up for at the start of the mortgage and also provide a clearer outline of how to calculate a potential IRD.
Banks do not have your best interest in mind when they calculate your mortgage rate or penalty to break that mortgage. Banks are profit centers that profit only by making a spread on the difference between the rate of interest that they pay you for your deposits and the rate of interest they charge you to borrow money. The more money you have on deposit with Bank, the more valuable you are as a client, and therefore the better the interest rate you are offered on your debts. With a Mortgage Broker every client has access to those great rates.
As always a competent Mortgage Broker is your best source of information. If you’re considering breaking your mortgage it’s best to speak to a mortgage specialist before making any final decisions. We can tell you if and when it makes sense to break a mortgage, without breaking the bank.
So If you are considering breaking your mortgage then I would recommend that you give us a call so we can go through your prepayment calculation together and then come up with the best strategy to minimize you penalty and offering you the sound, unbiased mortgage advice you deserve.
