# How to calculate the Interest Rate Differential penalty in a mortgage

“The penalty Banks charge is a mystery to many people and the way they calculate this penalty has changed and is not transparent” says Roy Singh from CENTUM Discount Mortgage Canada.

The way it used to work is that the Banks would either charge a three months penalty or the interest rate differential, whichever is higher.

Calculating the three months penalty is simple; you take the outstanding balance, multiply it by the interest rate, divide that number by 12 giving you one month’s interest, then times this by 3 (e.g. \$100,000 x3%/12x3= \$750).

However the way the interest rate differential used to work is that you would take the current rate you are paying, say 3.25%, and if you have two years to run, compare it to a current two year mortgage, say 3%. The difference would be .25% times the number of years remaining 2 years which would equal a penalty of .50% or in the above example \$500. So in this example they would charge the three months penalty because it’s higher. This makes sense because the banks can reinvest the money into a current mortgage and they are paid the difference, which covers their lost interest.

But no, this is not the way the Banks calculate this penalty now. Instead they don’t care what the current rates are, but look at their posted rates. Who sets their posted rates? When was the last time you called a Bank and they quoted the posted rates?

The way they calculate the penalty now is by looking at what their posted rates were when you got the mortgage, say it was 5.5%, but they gave you a discounted rate of 3.25% because that was what another Mortgage Broker was offering. They then calculate the difference between the posted rate and the discount rate, in this instance 2.25%, multiply it by the number of years outstanding, hypothetically 2 which equates to a penalty of 4.5% or \$4,500.

The way the banks calculate the penalty has changed without consumers being aware of this. What is our Finance Minister doing to protect consumers? He has made five mortgage changes to the Mortgage Act, all of which has benefited the Banks while hurting consumers. Yet, we don’t see him putting the brakes on credit card interest rates or how much a bank can offer in terms of credit card limits.

Roy Singh is a Real Estate Broker and a Mortgage Broker in Kitchener Waterloo.