Banks are in the business to make money, don’t ever forget that. When a bank agrees to lend you money for the purchase of a home, you can be sure that their calculations have been thorough and deliberate, and they know exactly how much money they stand to make from you over the course of the entire mortgage.
The problem is that most people don’t live in the same home for 25 years. The average household moves every 3-4 years, and because most borrowers choose 5 year mortgage terms, they will be faced with breaking their mortgage early and coughing up a penalty. Almost all lenders will allow a home owner to ‘port’ their mortgage over to their new house, allowing the purchaser to circumvent mortgage penalties. But if that’s not the case, the client will stand to typically pay THE GREATER of either:
- 3 months of interest payments or
- The interest rate differential (IRD)
Calculating 3 months of interest payments is easy, but figuring out your IRD is a completely different ball game!
In simplistic terms, the interest rate differential is the amount of money the bank stands to lose by allowing to break the mortgage because current interest rates are lower than they were at the start of the mortgage. Lets do a really simple example to illustrate:
But this is just a simple example. When lending institutions start calculating these amounts using posted rates instead of discounted rates, things go crazy and consequently the penalty amount skyrockets.
Your best bet is to read the fine print and ask specifically about mortgage penalty costs and how they are calculated when you sit down with your bank. This one conversation could literally save you thousands of dollars!
For more information about prepayment penalties, the Financial Consumer Agency Of Canada has an explanation.
In the meantime, if you have a mortgage with one of the popular banks, they have penalty calculators online. However, it would still be prudent to speak with them directly for a detailed explanation on the details of your financing:
- ING Direct
- Laurentian Bank
- National Bank of Canada
- Manulife Bank
- TD Canada Trust