Mortgage Penalties: The Banks’ Money Trap

What you will learn:

1) You will learn the 2 types of penalties for Variable rate, Fixed Rate and Line of Credit Mortgages.
2) You will be able to calculate your Penalties for your current mortgage.
3) You will know how to minimize your penalty if you need to sell and payoff your mortgage or refinance your property

1) Two Types of Penalties

Mortgages in Canada are of two types, Fixed Rate and Variable Rate Mortgages. Even though there are open mortgages (open means there is zero penalty) they are usually rare. If your mortgage is closed as the majority of mortgages are, the following two types of penalties will apply:

• 3 Months interest Penalty
o The lender will charge you 3 months interest as a penalty
o Example:
If your mortgage has a balance of $250,000 at 4.50%, you have 4 years left to go. Then the lending institution will probably charge you:
$250,000 x 4.5% x (3/12) months = $2,812.50 (Penalty)

• Interest Rate Differential Penalty (IRD)
o This means the difference between the interest rate on your mortgage contract compared to the rate at which the lending institution can re-lend the money. Note all Canadian banks and mortgage lenders calculate this in a different way.
o Now the government is working to pass legislation to bring clarity to this calculation. Banks are not clear and transparent regarding interest rate differential penalties calculation.
o Example:
If your mortgage has a balance of $250,000 at 4.50%, you have 4 years left to go and the current 4 year mortgage rate is 3.50%. Then the lending institution will probably charge you:
$250,000 X 4 years X 1% (4.50 – 3.50) = $10,000

2) How to Calculate your Penalty

• Download the Free Excel Mortgage Penalty Calculator
• Download and Print the Mortgage Penalty eBook
• Find your Mortgage Rate
• Strongly recommended to get a written quote from your bank for your penalty (sometimes banks will quote something verbally and then give you a surprise very different when you sell or refinance. Protect yourself!)

Regarding the Free Mortgage Penalty Calculator

• The penalties are approximate. This calculator is a guide only.
• Each lender has its own formula for calculating penalties.
• Some lenders do not use the discounted rates but posted rates. This decreases the IRD and can lower your penalty a lot.
• When determining the months left on your mortgage, some banks round up your remaining months to the next longest term. Some round down.
• The Interest Act rules IRD penalties on terms over 5 years. After 5 years a maximum 3-month interest penalty may apply. For example, someone who has been in a 7-year mortgage for 5 years or more would pay a 3-month interest penalty (maximum) to break it before maturity.
• A small number of lenders prohibit breaking a mortgage early unless you sell your property.
• Always get a written quote from your bank directly or via a Mortgage Broker for the exact amount.
• Variable Rate Mortgages: Use 3 Month interest Calculation only
• Fix Rate Mortgages: Use the higher of 3 Month interest and IRD calculation
• Lines of Credit Mortgages: They are open, so penalty is zero.

3) How to Minimize your Penalty

• Ask your lender if they would waive your penalty. Note they will offer you a blend and extend strategy. Proceed with caution as a blend and extend strategy will in most cases incorporate the penalty in the interest rate. This means the bank will not waive the penalty but give you a higher interest rate than what you can get with another institution. So instead of paying the penalty upfront, you pay it in monthly instalments.
o Example: Your penalty is $3,000, you have a 5% interest rate and you can get a 4% interest rate at another bank or with a Mortgage Broker. The banks offers you a blend and extend of 4.5%. Your mortgage is $200,000. This blend and extend will cost you in average $200,000 x (4.5%-4%) x 5 years = $5,000.
o In this scenario you pay $5,000 more over 5 years than the 4% offered by another bank. This means your $3,000 penalty becomes $5,000 over 5 years.

• Use savings or a Line of Credit to pre-pay 20% penalty free. Most mortgage contracts allow you to pre-pay 15% to 20% of the original mortgage balance without any penalty. If you have the funds, prepay this a few days before you sell your property or you refinance. This will save you on average 20% of the penalty.

• Sometimes the new lender will help you with the penalty. Fill out the form below to get a quote on how much the new lender may help pay for the penalty. Sometimes lenders have programs or promotions that can help you pay some of the expenses. Contact me to find out how much.

Camilo Rodriguez
Mortgage Broker, AMP
MortgagesLab | Origin
Tel   604.308-1721
Fax  604.630-7261

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