When there’s a lot of news about rising interest rates, I tend to get a lot of calls about what my lowest mortgage rates are. While searching for the lowest interest rate is fine, finding the right mortgage isn’t always about finding the lowest rate. And in some cases, the lowest rate can cost more in the long run with mortgage penalties.
When a client comes to see me for a new mortgage, whether it is for a purchase, refinance or their existing mortgage is up for renewal, I will give them the best rate available. But, I a going to put them in a product that is going to meet their needs and what is going to save them in the short term and long term.
Often, the mortgages with the lowest interest rates typically have inflexible and expensive payout penalties. The payout fee can eliminate any savings you had acquired through lower payments.
One of the key things I consider when placing a client’s mortgage is the penalty they face if they need to break the mortgage before their term is complete. And since people break their mortgage every 2 to 3 years, I don’t want clients paying unnecessary fees later on!
How are Mortgage Penalties Calculated?
The penalty for breaking a closed mortgage is calculated on either 3 months’ interest on the remaining balance or the interest for the remainder of the term on the remaining balance – this is called the interest-rate differential (IRD). Whichever of the two is higher, is the penalty fee.
Often, most banks will base their penalty calculation on their posted rate which is significantly higher than the actual rate they gave you or the other discount rate they offer for the remaining terms.
Here’s an example:
Say you owe a remaining $300,000 on your mortgage with 36 months left of a 5-year fixed term at the rate of 2.79%.
1) Mortgage Lender A bases their penalty rate on the discount rate they gave, 2.79% and their 3 year rate is 2.59%.
3 Month simple interest penalty: ($300,000 X 2.79%)/4 = $2,092.50
IRD: $300,000 X (2.79-2.59%) X 36 months /12 months = $1,800.00
Penalty is $2,092.50
2) Big Bank Lender B bases their penalty rate on their posted rate at the time you received the mortgage, 4.64%. You received a discount off their posted rate of 1.85%. Their current 3 year posted rate is 3.39%
3 month simple interest: ($300,000x 4.64%)/4 = $3,480.00
IRD: $300,000 X (4.64-3.39%) X 36 months = $11,250.00
Penalty is $11,250.00
That’s a difference of $9,158.00 in mortgage penalties for the same rate! The only difference is the lender and how they calculate their penalties.
Don’t get me wrong. There is a need to use the Big Banks, but if I have a client that can go with another mortgage lender that is offering the same or better rate than the Big Bank, I will place their mortgage with that lender.
Mortgage Penalty for a Variable Rate Mortgage
The mortgage penalties for breaking a variable rate mortgage is typically calculated of 3 months’ interest on the remaining balance. A variable-rate mortgage is a great option if you think you might need to break your mortgage early.
So, the only thing I caution you when you’re rate shopping is remembering that the absolute lowest rate might not save you the most in the long term. If you want to go through some numbers to see if a rate you found is a good deal, let me know! I’d be happy to make sure you’re getting the best mortgage and rate for you.