You bought an investment property with the plan to hold it for 5 years. The cheapest rate you found was on a closed mortgage, so you selected a 5-year term. Three years later, you need to sell. You call your bank and ask them “How much?”
That’s when your jaw hits the floor.
Early payment or pre-payment penalties charged by banks can be huge — thousands of dollars, or even TENS of thousands. Basically, with a closed mortgage, you have agreed to be bound by the terms and conditions of your mortgage until the mortgage term is complete. And that includes paying the bank a lot of interest.
Banks are not happy about losing all those interest payments just because you found a cheaper rate somewhere else. So most mortgages include specific language that restricts what you can and can’t do, as well as any penalties they charge to let you out of the contract (if they allow you to at all!).
Do You Know What You’re Signing?
Some of you may have heard me talk or write before about how everyone should learn to read legal agreements. Although most people want to defer that task completely to their lawyer, I highly recommend everyone make the effort. Why? Not so that you can replace your lawyer, but because they may not realize that a small detail is important to you.
You should always know EXACTLY what you’re signing and agreeing to,
especially it comes to banks and other lenders.
How Penalties Are Calculated?
Now a few of you may be thinking… aren’t mortgage pre-payment penalties standardized for all mortgages? No they are not. In fact, over the past few years, some lenders have become more ‘liberal’ with the interpretation of their vague penalty clauses in their contracts.
Traditionally, there is a very common method used to calculate any penalties you will owe if you decide to break your mortgage. You will pay the GREATER of the following:
- 3 Months Interest – Basically you take your next 3 mortgage payments, break out the interest portion, add them up, and that is your mortgage penalty, OR
- The Interest Rate Differential (IRD) - This one sounds complicated, but it’s actually quite easy (or should be). If you have 2 years left on a 5 year mortgage, find out what the lender’s current posted 2-year rate is, subtract that from your original rate, and multiply that by your mortgage balance.
- Spirepoint Real Estate ~ Paul Blacquiere