Wrapping Your Head Around Mortgage Penalties
You can scarcely go a week without hearing about mortgage rates in the news. There always seems to be something better out there! In the words of MoneySense magazine: “Being a homeowner with a mortgage can feel a bit like you’ve ordered the chicken dinner before realizing there was a steak special.”
No matter which way they’re predicted to go, you can’t help but wonder how mortgage rates affect you. Should you axe your current mortgage and hop onto a better rate at a different institution? Should you change up your terms so you can lock into a good rate for a long period of time? In theory, the sky’s the limit – provided you can stomach the penalties. I love educating homeowners about penalties, so let’s dive into the details.
Whoa. What Penalties?
If you break your mortgage, you can expect a penalty. In most cases, you’ll be expected to pay either three months’ worth of interest OR the interest-rate differential (IRD). That little word “or” is important, because you’ll be paying whichever penalty is greater.
The interest-rate differential or IRD is the equivalent of what the bank loses by releasing you from your mortgage and lending that same amount of money to someone else at the current rates. In short, you’re compensating your mortgage lender for the profit they lose when you jump ship.
Not all lenders calculate IRD in precisely the same way and, depending on their exact formula, the IRD penalty can cost you thousands or even tens of thousands of dollars. For instance, your old lender may have given you an interest rate of 2.99% for being a long-time client. However, the posted rate at the time was 4.9%. Some lenders will actually use that higher, posted rate when calculating the IRD penalty. Yikes!
If Penalties Are Bad, Why Would Anyone Break Their Mortgage?
The short answer is that sometimes you just need to get out of your mortgage! Less than 50% of mortgages go to their full time. Life is unpredictable. No matter how hard we try to prepare for difficult situations, it’s hard to anticipate just what will happen in the wake of a job loss, a critical illness, a divorce, or another big change. Penalties
However, not all mortgage breaks are the result of stress and hardship. Many times, homeowners initiate these changes voluntarily. In many cases, breaking a mortgage and accepting a penalty is a case of “no pain, no gain”. When the market shifts, it might be well worth the penalty in order to change the terms of your mortgage.
Even if you feel confident that you and your mortgage will be together for the long haul, I can work with you to ensure that favourable penalty terms are built into your contracts, just in case.
What If I Can’t Pay The Penalty?
Generally, mortgage penalties are rolled into the overall cost of your new mortgage, minimizing upfront costs to you. However, it’s important to note that when you roll your penalty into your new mortgage, you’re essentially paying interest on your interest-based penalty. I can run the numbers for a variety of different financial scenarios, so you know exactly much you “gain” in exchange for the “pain” of your penalty.
Are Penalties The Only Downside To Breaking A Mortgage?
Every time you break your old mortgage and sign a new one, you go through a round of paperwork. In addition to the usual bureaucratic fun, you can also anticipate paying an administrative or legal services fee from your lender. This removes the mortgage charge or lien against your property. Additionally, there are legal fees (which can often be rolled into your new mortgage) and possibly a property appraisal as well.
Some lenders make their special rates for new clients conditional upon moving banking services so they will hold your regular chequing and savings accounts. It’s up to you to determine if you feel a change of banking services is worth it in order to secure a strong mortgage rate.
Finally, if you have mortgage insurance through your current lender, that coverage will end when you switch providers. As even minor changes in your health can affect your insurance eligibility, it’s prudent to confirm your life insurance coverage if you have any concerns in this regard.
How Can I Avoid Penalties?
You might see some lenders advertising special terms which suggest they’ll pay the penalty for you. Before you get too excited, it’s time for us to have a conversation. Maybe they can pay that penalty for you because their rates and terms aren’t the best. Or maybe their deal isn’t all that it seems. That’s where I can come in and help translate all their financial figures and explain how they apply to you!
On a practical level, in some circumstances, it might make sense to make a large lump sum payment against your current mortgage. If your overall loan is lower, the amount of penalty you pay will be lower as well. However, not many people are in a financial position to take this approach.
Lastly, you can try to lower your penalty using one of the oldest techniques of all – complaining! Try reaching out to the bank manager, the regional vice president, even the bank’s ombudsman. You can even try the social media team! You have nothing to lose and a little pressure can work in your favour.
If this blog is as clear as mud, call me. I am here to clarity, educate, and support you throughout the process. You may only apply for a mortgage a few times in a lifetime; I process mortgages several times a day. Lean on me.