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, Make and RRSP contribution or investment, 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 remember that its not always about RATE, although important, there are other important steps you need to take into consideration when considering paying a penalty and shopping for a mortgage. Let a mortgage expert, put strategic steps and the right product in place that will ultimately make sure its in your best interest to pay a penalty and that your saving money.
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Author, Lisa Alentejano