Most mortgages in Canada have penalties based on the greater of 3 months of interest or the interest rate differential. Variable rate mortgages where the interest rate fluctuates with the prime lending rate usually have a 3 month interest penalty. Open mortgages most variable and fixed are usually at a higher interest rate but allow the borrower to pay out the mortgage at any time without paying a penalty.
Variable rate mortgages have very competitive rates right now depending on the prepayment options and other terms. Usually the penalty is limited to 3 months of interest but sometimes if the borrower has received an extra discount there may be a larger penalty – for example, 2% of the outstanding balance. This can make a huge difference if the borrower sells or has to pay out the mortgage earlier than expected. Another misconception borrowers have is that the 3 month penalty is calculated at the rate on the mortgage. Some of the major banks charge the penalty based on the posted rate for the current term. So, for example, if the mortgage rate was 2.15% (Prime-.70%) the penalty may be calculated at 3.85% which is the open variable rate.
Fixed rate mortgages are also offered at competitive rates and in some cases have restrictions in the extra payments a borrower can apply to the principal without penalty. There are also some lenders that are offering lower interest rates but an increased penalty if the borrower repays the loan before the term is up. Again this is in the 2-3% range and can increase the cost if the borrower had to sell. Similarly with variable rate mortgages, if the borrower has a 3 month interest penalty on their fixed rate term of 2.69% sometimes the banks may charge the mortgagor the penalty based on the posted rate of 4.29%.
When it comes to the interest rate differential there is a real spread in the procedure for calculating the penalty. The interest rate differential is the difference in the borrower’s rate compared to the current rate offered for the remaining term. For example, if the borrower had a mortgage rate of 2.69% with 3 years remaining and a 3 year rate was 2% then they would pay .60% of the mortgage balance for 3 years with most monoline (non bank lenders). However, again some lenders use their posted rate and the discount the borrower received, so if the posted rate was 4.69% when the mortgage was taken out the penalty becomes 2.69% of the mortgage for the remaining term. That is a HUGE difference in the penalty.
If you don’t know what your penalty will be to get out of your mortgage, we can help calculate that for you. We also offer the service of explaining how your penalty will be calculated prior to your signing approval for your new mortgage.
For questions or service, please call us direct.
Real Mortgage Associates
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As licensed Real Mortgage Associates and members of the RMA group we are focused on providing you with top quality mortgage advice.