Payout penalties explained:
On paper the penalties for early repayment of your mortgage look exactly the same from lender to lender, however this is unfortunately not the case and it could end up costing you thousands of dollars. For this reason it is very important that you have your payout penalties explained to you before you sign the mortgage commitment.
For variable rate mortgages your pay out penalty is almost always three months of interest. For example if you have a $200 000 mortgage at 2.5%, your approximate pay out penalty would be calculated as $200 000 x 2.5% interest / 12 months to receive a monthly interest cost x 3 months interest = $1250.
For fixed rate mortgages your penalty is almost always the greater of either three months of interest or the interest rate differential (IRD). The IRD is a measure of the money the lender is losing by you repaying your mortgage early versus what they are able to re-lend it at for your term remaining.
If you have a $200 000 mortgage with an original five year term at 3.5% and you have two years remaining on your term and the current two year re-lending rate is 3.0% the calculation would be: $200 000 mortgage amount x (3.5%-3.0%) which is the difference in your current rate versus the re-lending rate x 2 years remaining on your term = $2000
How the big six banks make extra money on your penalty:
So far this explanation seems pretty simple and straightforward, however the Canadian banks have a rather devious way of using this formula but changing the input numbers so your payout penalty with the IRD increases by thousands of dollars. Most Canadian trust companies use the true and accurate numbers so your penalty with them could be thousands less than the banks.
The difference in the calculation is that most trust companies will use their actual re-lending rate for the IRD where as the banks create a generally unrealistic rate by using what they call your “original discount off the posted rate”.
If we look back to our original example the trust company is re-lending two year mortgage money at 3.0% and your rate is 3.5% so they are legitimately losing 0.5% over the remaining two years of your mortgage and they will charge you for it – I think we can agree that this seems fair.
The banks however will manipulate the re-lending rate by applying a discount off of the posted rate in order to receive a higher pay out penalty from you.
If we assume your five year fixed rate is 3.5% and the original bank posted rate at the time of your approval was 5.24%, then you received a discount off the posted rate of 1.74% (5.24%-3.5%). However these discounts vary and tend to increase when you select a longer term. A typical discount off the posted rate for a two year term is 0.35%, meaning that if the current two year lending rate is 3.0% then the two year posted rate is often 3.35%. Now this is where the bank calculation becomes unrealistic and can be very detrimental to you.
When you pay out your mortgage the banks will apply the original discount you received off the posted rate against the current posted rate for your term remaining to determine the re-lending rate. In our above example this would mean that the bank would determine the two year re-lending rate as follows:
3.35% current two year posted rate – 1.74% your original discount off of posted = 1.61% current re-lending rate. Obviously this is not the bank’s true two year rate but is is the number that they will use to calculate your penalty for early repayment.
This part is very important and could save you thousands of dollars:
With our above example and explanation, if you have a $200 000 mortgage with most trust companies and you are planning on paying it out early based upon the above numbers, your pay out penalty would be $2000. However with a bank mortgage based upon the above number your pay out penalty would be more than triple at $7560! Now lets look at these numbers if you had a $400 000 mortgage, your trust company penalty would be $4000 and your bank penalty would be a staggering $15 120!
As a mortgage professional we always seek to educate our clients and also protect our clients to ensure they receive the very best mortgage fit for their plans and goals.
Please feel free to contact us via phone, online contact form, or by applying online so that we can ensure you are fully protected within your mortgage and that you receive the best rates today and best terms in the future.