AKA Mortgage Cancellation Fees, Payout Penalties, Pre-Payment Penalties…
Whatever you want to call them nobody likes them. They can be unfairly inconsistent from lender to lender, and can be difficult at times to ballpark or “guesstimate” for clients. The Canadian Bank Act dictates no consistency or single standard for how lending institutions recover the earnings they lose on an early mortgage payout, or prepayments.
Many Canadians today are refinancing to take advantage of lower interest rates, consolidating debt, or both. Clients could see some hefty interest penalties, and it can be confusing. When you pay-off your mortgage prior to its maturity, and break the existing mortgage term you are assessed either a three month interest penalty, or an IRD (interest rate differential). Even though when you sign your original mortgage documents, and it outlines the details of the “cancellation fee” policy, the lender may at its own discretion change the terms and conditions of their policy.
Here are the two common lender calculations:
Most lenders apply both, stipulating “whichever is the greater of the two.” If you have a VRM (Variable Rate Mortgage) you would use the 3 month interest penalty.
Three months’ interest penalty – Lenders guidelines may vary from institution to institution but most lenders will calculate your current interest charges for your next 3 mortgage payments.
To estimate the Three Months’ Interest Costs:
| Step 1: ________ (A) | amount of your mortgage |
| Step 2: ________ (B) | the Interest Rate under your Mortgage expressed as a decimal (for example, 5.25% = .0525) |
| Step 3: ________ (C) | A x B = C |
| Step 4: ________ (D) | C ÷ 4 = D, D is your estimated Three Months’ Interest Costs |
Interest rate differential – The IRD amount is calculated on the mortgage amount being paid out using an interest rate equal to the difference between your existing mortgage interest rate and the interest rate that your lender can charge when re-lending the funds for the remaining term of the mortgage.
To estimate the Interest Rate Differential Amount:
| Step 1: ________ (A) | the current interest rate under your Mortgage expressed as a decimal (for example, 5.25% = .0525) |
| Step 2: ________ (B) | the current interest rate that your lender can charge for a mortgage term offered by that lender with the term closest to your remaining term. |
| Step 3: ________ (C) | A – B = C, which is the difference between your current interest rate and the interest rate in B above (write C as a decimal) |
| Step 4: ________ (D) | amount of your mortgage |
| Step 5: ________ (E) | number of months for the remaining term of your Mortgage |
| Step 6: ________ (F) | (C x D x E) ÷ 12 = F, F is your estimated Interest Rate Differential Amount |
On Leverage: “And as we all learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.”
