If you want to refinance your mortgage, transfer it to another lender or sell your home, before your term is up, you’ll find yourself facing a hefty penalty fee. The fee, also known as a prepayment penalty, is your bank’s way of penalizing you for breaking your contract early.
While the banks all have their own prepayment calculators, the legal jargon used around them is enough to leave even the most educated homeowners confused; they also do little to show you how they come up with the final number. Because of this, we decided to research each bank’s calculations and build our own mortgage penalty calculator, so no one is left in the dark about how these penalties work.
Depending on whether you have a fixed or variable mortgage rate, the bank will charge you one of two prepayment penalty fees:
- three months’ interest, or the
- interest rate differential (IRD).
If you have a fixed mortgage rate, you will pay the greater of three months’ interest or the interest rate differential. If you have a variable mortgage rate, however, you will always pay just three months’ interest. Here’s how both calculations work.
Three Months’ Interest
Three months’ interest is exactly that: the amount of interest you would have paid in a three-month period on your current mortgage. Calculate three months’ interest by multiplying your current mortgage rate by the mortgage balance and again by 0.25 (represented as 3/12 for the three-month period out of the year).
Let’s assume you still owe $200,000 on your mortgage, have a variable mortgage rate of Prime – 0.50% (which means its been 2.50% since the day you got your mortgage, because Prime has been at 3.00% since September 2010) and you live in Ontario. Here’s what you would enter into our mortgage penalty calculator:
As you can see in the calculation below, three months’ interest in this example amounts to $1,250. In Ontario, however, Scotiabank also charges its borrowers a $270 fee for having to discharge a mortgage from them, so we added that to our calculator:
In this example, because you had a variable mortgage rate, the bank would charge you the three months’ interest penalty fee of $1,250 + $270 to discharge your mortgage for a total of $1,520. If you had a fixed mortgage rate, however, you would still need to find out if three months’ interest was more or less than the interest rate differential…
Interest Rate Differential
The interest rate differential (IRD) is your lender’s way of determining how much interest they’ll be losing by letting you break your contract early – and making you pay it to them. To calculate the IRD, your lender looks at your mortgage rate, how much time is left in your mortgage term, and the mortgage rate they could charge someone now for a new term equal to the remainder of your term.
Instead of looking at your current mortgage rate and finding the difference between that and today’s best rate, however, the bank finds the posted rate from the day you signed your term and subtracts today’s posted rate for a product that would cover the remainder of your term from that. Are you confused yet? This is just another reason we knew we had to develop this calculator.
Using the same numbers from the example above, let’s say your mortgage balance is $200,000 and you have 24 months left in your term. The bank would first figure out what the posted rate was for a 5-year fixed term on the day you originally signed your contract with them (it was 5.49%).
Then, the bank would find out which product would cover the remainder of your term – in this case, you would need a 2-year fixed mortgage rate, and today’s posted rate for that product on their site is 3.14%. Because our calculator does some of that work for you, here’s all you’d need to enter into our calculator:
As you can see in the calculation below, the IRD in this example amounts to $9,400. Remember that, in Ontario, the bank also charges its borrowers a $270 fee for having to discharge a mortgage from them, so we added that to our calculator:
In this example, because you had a fixed mortgage rate, the bank would charge you the greater of three months’ interest or the interest rate differential (IRD). Since we know three months’ interest was only $1,520, you would have to pay the IRD, which is $9,400 + $270 to discharge your mortgage for a total of $9,670.
Other Penalty Fees
While our calculator gives you a good estimate of what you’ll have to pay to break your mortgage term early, there can be a number of other fees involved. One of them is a discharge fee, which we’ve included in our calculations, and this fee varies from province-to-province.
If you live in Ontario, New Brunswick or Newfoundland, you will also have to pay a registration fee of $71.30 for the bank to register your new title. In all other provinces, you have to pay this at your municipal land title office, instead.
Note: In Quebec, you pay all other fees through a notary.