Nobody wants to pay penalties.
According to the statistics, over half of Canadians with a mortgage renegotiate or refinance before their term is up. The standard term on mortgages is 5 years, but the average borrower will change their mortgage every 3.5 years.
Even if you don’t plan on changing your mortgage in the next five years, plans change and it can be very difficult to predict your life circumstances five years in the future.
It can pay to understand the costs involved if you do want to break your mortgage before your term comes due and know what kinds of penalties you’ll be facing. Getting to know the difference between a three month’s interest penalty and Posted Rate IRD (Interest Rate Differential) Penalty could save you thousands of dollars in penalties if you break your mortgage.
Before you sign the dotted line on your mortgage commitment, be sure to ask your mortgage broker or agent these questions about the penalties involved.
Can I break my mortgage any time I want?
If you have an open mortgage, by definition you can pay it off in part or in full at any time, though that usually comes with a built in cost of a comparatively higher interest rate. For closed mortgages, most lenders allow you to pay a prepayment penalty to get out early. The type of penalty you pay depends on the method the lender uses to make the calculation.
The calculation can come in a variety of flavours, from the three month’s interest penalty to the Discounted and Posted Rate penalty.
If mortgage penalties do apply, how are they calculated?
Your mortgage penalty will depend on which lender your mortgage is with and whether your mortgage has a fixed interest rate or a variable rate. Fixed rate penalties are usually three months interest or one of the IRD calculations, whichever is more. For variable rate mortgages, the penalty to break those are typically three month’s of interest at your current rate.
The vast majority of the time the penalty to break your fixed mortgage will be calculated using the Interest Rate Differential. If your mortgage lender uses the Discounted or Posted IRD Calculation to determine your mortgage penalty, it could mean you will be paying thousands of dollars more than if they use the Standard IRD Calculation. This is more common with the large banks like RBC, TD, and Scotiabank and is one of the biggest weaknesses in the market.
The trouble is these lenders make the way they calculate their mortgage penalties fairly obscure and difficult to understand and most borrowers have no idea what the different options mean. Couple that with the fact that most borrowers don’t get into a mortgage expecting to break it early, despite the stats saying that’s most likely going to be the case, and you have a recipe for these lenders making a large profit off of their mortgage penalties.
Is my mortgage portable?
What do you think the odds are of you moving at the same time your mortgage term comes up? Pretty slim most likely. When working with a broker, make sure they know to work with lenders that allow for portability, especially if you’re young or have a growing family.
One thing to consider is that credit unions usually allow you to port your mortgage, but not if you’re moving to another province. Also, if you have a line of credit with your mortgage, make sure that you can port that as well and keep your current rate.
If I break my mortgage early, can I use my unused prepayment privileges to lower the penalty?
Some lenders allow you to apply your unused prepayment privileges to your mortgage penalty, others don’t.
If the mortgage includes cash back, how much of that cash do I have to repay if I break the mortgage early?
Typically you will have to repay a pro-rated amount if you break your mortgage early, but some lenders will make you repay 100% of the cash back even if you break your mortgage only one day before your term comes up.
If you have a cash back mortgage, don’t let this one surprise you!
The majority of Canadian borrowers have no idea that there are significant differences in the way that mortgage penalties are calculated and applied, and the major lenders have been taking advantage of this for years.
Don’t be one of those borrowers who doesn’t know what they are getting into when they sign on for their mortgage, ask the important questions because you never know what the next five year may hold. At the same time, it’s important to work with a mortgage broker that has your best interests in mind when looking for the mortgage solution you need, but brokers aren’t mind readers.
Since borrowers are typically looking for the best rates this means that your broker will too, that is unless you tell them what you want in a mortgage. Portability and reasonable penalties should definitely be near the top of your list.
Ardent Mortgages is a VERICO mortgage brokerage and specializes in helping homeowners in Ontario refinance their mortgages and consolidate their unsecured and high interest debt. If you are purchasing, refinancing or renewing your mortgage, contact Ardent Mortgages or use our 90 Second Application to obtain the best available rates and terms.