Mortgage Penalties
A mortgage penalty is a fee or charge that Ontario mortgage borrowers will face if they end their mortgage contract before the term has completed. Mortgage penalties may also occur when the borrower wants to make a lump sum payment that is more money than allowed within their contract. These penalties are there to ensure that the lender is compensated for the associated costs of ending the mortgage early. The specifics of what a borrowers penalty will be is determined by the lender, the mortgage contract, as well as what terms were established. In Ontario, there are two common types of mortgage penalties.
Fixed Rate Mortgage Penalties
Typically, the penalty will be whatever is greater of the following:
1. Three months interest
[(contract interest rate/12) x mortgage balance] x 3 = three months interest penalty
2. Interest rate differential (IRD)
[(contract interest rate - current interest rate)/12] x mortgage balance x remaining term = IRD penalty
I know what you’re thinking, what is an IRD??? The IRD is the difference between the interest rate the borrower was paying and the current interest rate that the lender could charge for a mortgage with a similar term. If the interest rate has decreased since the borrower has started their mortgage, the penalty could be quite high. This is because if your current mortgage is a higher rate than what they’d get the day you end your mortgage, the lender will be losing money. Let me break it down further with the formula details and then a full example.
Current Interest Rate: This is the interest rate that the lender could charge for a mortgage with a similar term to the borrowers at the time they decide to terminate their mortgage.
Mortgage Balance: How much of the borrowers mortgage is still left.
Contract Interest Rate: This is the interest rate the borrower has agreed to in their current mortgage contract.
Remaining Term: The number of months left in the original mortgage term.
Note: Some lenders might use different formulas.
Example:
Let’s say you have $350,000 still left on your mortgage that you’d like to pay out. Your contract interest rate is 5%, and you have 3 years left on your term. For a 3 year term, with your lender the current rate is 4%.
Three month interest rate penalty:
three months interest penalty = [(contract interest rate/12) x mortgage balance] x 3
three months interest penalty = [(0.05/12) x $350,000] x 3
three months interest penalty = $4,375
IRD Penalty:
IRD Penalty = [(contract interest rate - current interest rate)/12] x mortgage balance x remaining term
IRD Penalty = [(0.05 – 0.04)/12] x $350,000 x 36
IRD Penalty = $10,500
Therefore in this example, the lender would charge $10,500 in penalties because it is the greater of the two calculations.
Variable Rate Mortgage Penalties
These types of mortgage penalties are almost always calculated based on three months worth of interest.
Each lender may have different calculations for how they want to implement their mortgage penalties. However, nowadays, Ontario lenders have a regulation where they have to disclose how they will calculate a borrower’s mortgage penalties. This is to honour transparency and fairness to the borrowers.
In my opinion, a crucial piece to selecting a mortgage is understanding it in its entirety. This includes knowing exactly what the mortgage penalties are going to be. As a borrower, you don’t know when your circumstances are going to change, so it’s always good to know what your options are for breaking your mortgage or for trying to pay it off early. As a professional, I am always happy to go through your mortgage contract with you, from the beginning, during a renewal, or any other moment that you may have questions. You can book a meeting with me here.
