How to Figure Out Mortgage Payout Penalties
If you’re selling a home and have a mortgage that isn’t portable, you need to understand how mortgage penalties are calculated.
For example, if you’re only two years into a five-year fixed mortgage and you’re buying a new home but don’t have that portable mortgage, most lenders will charge you an early-payout penalty. The penalty will be outlined in your mortgage documents.
Most Common Penalty
The most common penalty is the greater of three months’ interest or the interest rate differential. This means that whichever amount is the larger of these two figures will be your penalty.
Three Months’ Interest Penalty
If you are paying off your mortgage before the maturity date, most lenders charge the three months’ interest penalty, which is calculated by taking the mortgage balance, multiplying by the annual interest rate and dividing by four.
Interest Rate Differential
The interest rate differential usually means the difference between the interest rate on the current mortgage compared to the rate at which the lender can relend the money.
For example, if the mortgage has a balance of $125,000 at 6.25%, and there are two years left to go and the current two-year mortgage rate is 3.25%, the lender will probably charge $125,000 x 24 months x 3% (6.25 – 3.25) /12 = $7,500. Some lenders might lower this amount because the entire interest payment is being paid immediately rather than being extended over the longer term.
When interest rates are low, and you are looking at debt consolidation or moving home, then it might be to your advantage to pay the penalty on the current mortgage and get into a new mortgage with a better rate. Such a move can save you thousands of dollars in interest.
Guy Ward is a Mortgage Associate in Calgary, Alberta with TMG (The Mortgage Group Alberta).