Have you ever needed to get out of your mortgage before the maturity date? It can be a confusing and surprising experience. Don’t forget that your mortgage is a legal contract, therefore, like most contracts it is expected that it would cost you to break it.
The lending institution will have two options to determine how much you will pay, but first they will consider the type of mortgage term you have. Is it a variable rate or a fixed rate? If it’s a variable rate, you most likely will pay three months interest max, but if your term is fixed, you will pay either the Interest Rate Differential (IRD) or three months interest, WHICH EVER IS GREATER.
Three Months Interest Penalty
Determining how much three months interest will cost you is usually pretty simple; take the remaining mortgage balance, multiply by the interest rate, divide by 365 to get the daily amount, then multiply by 90 (for three months) and you got it. Of course, you must verify your figures with your financial institution, but you get the picture. Or look back through your paperwork to fine your amortization schedule, if that can’t be found call your mortgage broker, he/she will have a copy.
Interest Rate Differential
IRD is more complex. In simple terms, the financial institution wants you to pay them back for the loss in revenue that they may experience when you pay out the mortgage early. So if you have two years left on your mortgage, and they can’t loan out the same funds for at least the interest rate you are paying they will want to be compensated for their loss.
For example; if your current rate is 5% but they can currently can only loan out those same dollars at 3%, they will want you to pay them the 2% loss.
With me so far? Here it comes…
Say your rate of 5% was a discounted rate at the time received, most are, and the posted rate at the time was actually 7%, the financial institution may actually charge you the difference between the 7% and the current 3%, or something even more complicated. There could be a difference of thousands of dollars!
Most banks and financial institutions have different ways of calculating their early discharge penalties, therefore, it is imperative that you find out how they will calculate this penalty upfront before you initially sign for your mortgage, especially if you think you might need to get out early.
A mortgage specialist will take a financial planning approach to sourcing your mortgage options and will help you throughout your decision making progress, making sure that you not only consider your current situation but make sure you look at future scenarios as well.
The good news is that we have access to lenders who will calculate your penalty using your discounted interest rate against the current discounted rate when calculating the penalty.
If you are considering paying out your mortgage early, it is vital that you contact your mortgage specialist or financial institution to obtain a written calculation on how this penalty will be calculated before finalizing your plans. Knowing the costs prior to making the final decision on a house sale/purchase or early discharge can save you thousands of dollars and a lot of stress!
Better to know up front, than being surprised later!