Breaking your mortgage before your term is up can have significant financial consequences. That’s why it’s important to weigh all of your options before taking action to ensure it’s in your best financial interest.
What are payout penalties?
Lenders make money from holding your mortgage, primarily through interest payments. If you pay out your mortgage early, you’re essentially reducing the amount of money your lender makes. In order to offset some of these losses, lenders impose penalties.
How are the penalties calculated?
Typically, payout penalties are equal to a percentage of your current mortgage amount or the equivalent of a certain number of monthly interest payments. In either scenario, the fees can quickly add up.
Most fixed-rate mortgages have a prepayment penalty that’s based on either three months’ interest or the interest rate differential (IRD). The IRD is a charge applied when you essentially break (pay off) the mortgage prior to its maturity date. It’s calculated based on the amount that’s being prepaid, and the difference between your original interest rate and the lender’s current interest rate. Most variable-rate mortgage penalties are three months’ interest and don’t typically carry IRD penalties.
Payout penalty calculations vary from lender to lender, so it’s vital to have your mortgage agent review your mortgage contract to determine how yours will be calculated. Ideally, this is something you want to be aware of before even signing a mortgage contract. You’ll also receive guidance on the risks and benefits of paying off your mortgage early to ensure it’s the right thing to do.
Banks typically use their posted rate to calculate the penalty amount. Posted rates are generally higher than the actual interest rate borrowers can expect to receive. Other lenders, such as monolines and credit unions, base their calculations on published rates, which are generally more inline with the actual rate borrowers receive. That’s why you often hear reports of bank IRD penalties costing borrowers thousands of dollars.
Have questions about payout penalties or your mortgage options in general? Answers are a phone call or email away!