With interest rates at historic lows many home owners are seeking to refinance their current mortgage prior to the scheduled maturity date. It is an excellent idea to review this option as the potential savings is generally in the thousands, if not tens of thousands of dollars.
In the past many lenders were content to dissolve a mortgage with a three month interest penalty, but given the number of early redemptions, and revenue lost, lenders now rely on collecting the greater of three months interest or an amount called the Interest Rate Differential. The IRD is based on:
- The amount you are pre-paying; and,
- An interest rate that equals the difference between your original mortgage interest rate and the interest rate that the lender can charge today when re-lending the funds for the remaining term of the mortgage.
Most closed fixed-rate mortgages have a prepayment penalty that is the higher of 3-months interest or the IRD. Variable-rate mortgages do not typically have IRD penalties.
Logic dictates that a simple formula would exist for calculating IRD. We have software for such purposes, but in my experience this is an exercise in futility. The reason is that each lender has their own formula for calculating penalties and even the lenders own employees are sometimes unsure as to what the penalty should be. Some lenders use posted rates for their IRD calculation and some use discounted rates. Some lenders round up to the next longest term when determining comparable IRD interest rates, some round down. A small number of lenders prohibit breaking a mortgage early, regardless of the penalty, except in the case of an approved bona fide sale.
My recommendation is that you contact your lender directly for an exact penalty quote, but in my experience even that amount may change, prior to the closing of the new financing. In one example, CIBC provided a payout statement only to present the client’s lawyer with a different payout amount on the day of closing. As you can expect the client went ballistic with the last minute change, as the reason to proceed in the first place was of course predicated on the amount of the penalty when compared to the savings of the new mortgage terms. When CIBC was asked why they were not prepared to honour their original commitment, and why they were increasing the penalty on the day of closing their answer was simply this, “Because we can”.
At best your mortgage agent will be able to verify your expected penalty amount and hopefully your current lender is not a $#%&*.
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