Many of us have had the unpleasant shock of learning what our mortgage prepayment penalty actually is at very inopportune times. Such as after a firm sale on our home, or at the lawyers office when sitting down to refinance.
Having had my own experience with this back in 1998 it is something that I have always been acutely aware of and generally try to cover off within the first 20 minutes of conversing with a client.
The simple generalizations currently are that a variable rate mortgage will only ever have a 3 months interest penalty to break out early. (not 3 months full payments, just 3 months interestexpense) This is typically equivalent to less than 1% of the mortgage balance. (there are rare exceptions to this rule)
Whereas a fixed rate mortgage, even one of those attractive-at-the-time 3.69% 5 year fixed from 2009 will often shift from the 3 month interest penalty over to the IRD (Interest Rate Differential) resulting in a penalty as high as 4% or even 5%of the mortgage balance.
The methodologies used by lenders to calculate IRD are varied and borderline Byzantine in their nature. One could be excused for thinking that the lunar cycle, tidal flow, and perhaps the sacrifice of some poultry must be involved in coming up with an ever-changing number.
The potential for large penalties triggered by breaking out of a 5 year fixed rate mortgage prematurely is the key reason to consider the merits of a variable rate mortgage, or possibly shorter term fixed rate product. With 2 year and 3 year fixed rate money as low as 2.69% there is a conversation to be had there for sure.
At last there are some steps toward clarity being taken with regard to IRD’s though.
Announced by TD this morning;
SUBJECT: Enhanced Disclosure of Mortgage Prepayment Charges
The Government recently made changes to mortgage prepayment disclosure requirements to ensure customers are provided with the information they need to make a well-informed discharge or prepayment decision. In keeping with our focus on compliance and applying a customer-focused approach to our practices, beginning July 25, 2012, the following changes will be made:
- Discharge and Information Statementswill now include:
- Rate discount details
- Explanation of the Interest Rate Differential (IRD) calculation and factors that impact the IRD
- To access the Prepayment Brochure, refer to www.tdcanadatrust.com/mortgages, under Mortgage Resources.
- To access the online prepayment calculator, visitwww.tdcanadatrust.com/prepaymentcalculator.
- Toll-free phone number (English/French: 1-800-281-8031 / 1-800-294-0954) where customers can call for information about prepayment charges and online prepayment calculator support.
Note: As the online prepayment calculator results are estimates only, to obtain the exact prepayment charge amount, a Discharge Statement must be requested from the branch.
Your Mortgage Broker, and the start the conversation there.
Have an excellent day!