How To Shop For A Mortgage (Part 3 – Mortgage Penalties)

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Hi Ryan Zupan here with the City Wide Mortgage services. This video is part of our series on what to look for when shopping for a mortgage & today we are going to cover mortgage penalties.

Mortgage penalties, without question, can have the largest impact on how much your mortgage is going to cost you.  They can range from very the manageable to the borderline devastating.  Some of you have probably heard horror stories or news reports of clients getting hit with penalties of $20k-$30k.  I can tell you, these stories are very much true & exactly why you need to know what kind of mortgage you are signing up for.

For this video, we are going to talk primarily about penalties on fixed rate mortgages & the reason for that is with most variable rate mortgages out there, the penalty for breaking is going to be 3 months of interest, so whatever interest you pay per month, multiply that by 3.  On the penalty side of things, this is what you want.  It’s a lower penalty that what you’ll find with different types of mortgages out there.

Now there are exceptions to that.  Right now there are a few variable products out there that have a very low rate, which is great, but they have EXTREMELY high penalties.  I’m talking a flat penalty of 3% of the mortgage balance.  So on a $400k mortgage, that’s a penalty of $12k, which is huge.  Especially when you compare that to what you are saving going with that lower rate option.

On that $400k mortgage, the difference of 0.05% on interest rate, so let’s say 2.3% compared to 2.35%, is around $10 / month, which isn’t really that much.  Is it worth risking a penalty that has the potential to be $9k or $10k higher than other options to save a mere $10 / month ?  Probably not, so, again, it is vital that you know what you are signing up for.

Now with fixed rate mortgages, the penalty is a bit more complicated.  It’s the GREATER of 3 months interest (same penalty as the variable) OR a calculation called the interest rate differential (IRD).  The IRD is a formula the lender uses which factors in how much money they will be earning when they relend your money out for the remainder of your term.

For example, if you’re 3 years into your 5 year term, the lender wants to know how much they will earn relending your money out on a 2 year term.  If the 2 year rate is higher than your interest rate, then the lender will be better off — the lender is going to make more money.  If your rate is 3% & the 2 year rate is 4%, the bank is going to be better off, so your penalty will just be 3 months interest.  On the flipside, if rates are lower – if your rate is 3% but the 2 year rate is just 2.5% — then the bank is going to lose money once you break the mortgage.  It’s these situations where the penalties can be quite high.

Now, the kicker to all this is that the IRD calculation differs from bank to bank.  Some lenders will do a straight rate comparison – if your interest rate is 3% & the 2 year rate is 4%, they compare one rate to the other.

BUT, for some institutions, it is not that simple…  some factor in discounts they gave you off of their posted rate, some base the comparison rate on the corresponding bond yield.  There are a lot of differences that can really impact what your penalty could end up being.

By no means am I trying to dissuade you from taking a fixed rate.  There are certainly advantages of going fixed & for many borrowers that’s definitely the right fit, but I do want you to be asking these questions going in.  A mortgage is more than interest rate.  Don’t just go for the lowest rate.  Know what you are signing up for.  Make sure it’s the right fit.  You will thank yourself down the road.

I’m Ryan with City Wide Mortgage Services.  Please contact me & I’d be happy to go over this in more detail with you.

Ryan Zupan
Mortgage Planner
ryan@citywidemortgages.ca
604.250.6122