Todays market is bringing alot of questions about whether you should consider refinancing your mortgage for a better rate. There are many different reasons people might re-negotiate their current mortgage. You may be considering using some of the equity in your home you have built up and use it to buy a rental property, pay off some high interest rate debt or just renegotiate your current rate for a better more competitive rate and lower monthly payment.

Below are some ways in which you can get a good idea on what kind of penalty you may be faced should you want to refinance your current mortgage. Again these are used simply as a guideline and are in no way exact. The lending institution you are currently dealing with will give you the exact amounts relating to your specifac situation.

## Calculating Payout Penalties & Interest Rate Differentials (IRD)

Many closed mortgages include a clause stating that the payout privilege on the mortgage will be a three-month interest penalty, **or** interest differential, **whichever is greater**.

- $300,000 remaining on the mortgage
- 3 years into a 5-year fixed term at 5.5%
- Today’s interest rate: 3.5%

We’ll just be using the *simple interest *amount – the actual amount of the penalty could be a little less than the amount quoted in the examples.

**Three Month Interest Penalty :**

**Mortgage Balance X Interest Rate X 3 months**

Plugging in the variables above, we would get:

= $300,000 X 0.055 X 0.25 (5.5% = 0.055, 3/12 = 0.25)

= **$4125.00 would be the 3 month interest penalty**

Now we have to calculate the interest differential – and that’s where penalties can be quite substantial – especially since interest rates have dropped considerably lately.

**Interest Differential Penalty:**

** Current Mortgage Balance X Interest Rate Differencial X Time remaining**

=$300,000 X 0.02 X 2

(0.02 = 2% which is the difference from 5.5%-3.5%, and 2 years left in term)

=$12,000.00 would be the Interest Differential Penalty

In the example above, the bank would then use the Interest Differential Penalty since that amount is the greater of the two. Remember that the way banks calculates their penalties sometimes is a mystery to me and can be greater than the figures above so make sure you ask. Please speak to your mortgage broker for your personalized mortgage advice, as payout penalties are dependant on the contract you signed and remember are subject to change.

Are you now ready to look a little more closely on whether or not you should refinance your mortgage, pay the penalty (which we can most likely build into your new mortgage) and still save thousands of dollars in interest. Contact me direct at 1-888-819-6536 or email me at lisa@mortgageplayground.com. You’ll be able have all the information you need to make an informed decision. Expert, unbiased advice is what i offer to all of my clients.

Author, Lisa Alentejano

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Excellent article! Would be worht mentioning that many banks are now calculating their IRD’s with slightly different formulas. Specifically, using discounts off posted or forcing clients to calculate IRD against an inflated posted rate. Great reading for consumers and Mortgage Brokers alike. Thanks!