There are many things to consider when you are getting your mortgage, rate is just the tip of the iceberg. Rate is focused on the most since it is advertised all the time by lenders and mortgage brokers. Some other things to consider are the term length, prepayment privileges, variable vs fixed mortgage and last but not least, penalties. Every closed mortgage, a very high percentage of mortgages that are taken out, will have penalties for early payout of the mortgage. How these penalties are calculated are very important and not always the same from lender to lender.
Typically there are 2 ways that a penalty is calculated on a fixed rate mortgage. A 3 months interest penalty or interest rate differential (IRD). Banks will charge you whichever is larger if you pay out your mortgage before term end.
3 months interest is very simple; take your interest for the next 3 months.
IRD is where things can get out of hand. There are a few different ways this can be calculated but you will mainly run into one of the following. Lenders that do not have posted rates will take the difference between your contract rate and their current rate for the remaining years on your mortgage. This will be multiplied by the remaining years and then the outstanding mortgage amount. One thing to note about this calculation is that if current rates are higher than your contract rate you will always pay the 3 months interest penalty. Lenders with posted rates take advantage of these rates to make sure there is a better chance of paying a higher penalty. The main difference is that they will tell you when you got your mortgage they offered you rate A (market rate) but they could have offered you rate B (posted rate). Since they gave you a discount and now you are breaking that contract they will work that discount back into the penalty calculation. Today the difference could be a contract rate of 3.09 vs a posted rate of 4.99. By doing this they increase your chances of having a much higher penalty. Based on today's situation as an example, people with the first lender would have a penalty below 1% of the mortgage balance on average. People that are with lender number 2 would have a penalty as high as 4% on average. Significant difference when you are dealing with mortgages.
In the end you should be having this conversation with your mortgage professional/lender. The chances are if you are dealing directly with a lender that has the higher calculation you are not going to be offered this information freely and they may not even inform you of the differences. Since Your Mortgage Guru works for you we are here to educate you and put you in the best mortgage for you.
This article is in the category: General.