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Mortgage prepayment penalties in a low interest rate environment
February 6, 2015 @ 11:13 AM by:

In the last month or so, fixed rate mortgage offers below 3% have become very commonplace (which is terrific). However, before blindly jumping into a 5 year fixed rate mortgage (especially with one of the big 5 banks) you need to take a moment to read about how they will calculate penalties if you pay them out early (you likely won't hear this from them).

Let's work through an example. 

In February 2012 you took out the following mortgage with a bank:

Mortgage amount: $150,000
Amortization: 25 years 
Contracted rate: 3.89% fixed for 5 years
Rate discount you received at time of signing: 1.50%
Current rate on a 2 year term (February 5) 2.39%

Seems like a pretty typical scenario, as most borrowers always receive a discount vs. the bank posted rates. When reading the penalty language in the bank contracts, you are generally charged the greater of 3 months interest or interest rate differential (which is the difference between the rate you have and the discounted rate they are giving new customers for a comparable term). What the 5 big banks do, however, is to compare the POSTED rate at the time you took out your mortgage to the discounted rate they are giving new customers. Your penalty would look something like this:

(5.39%-2.39%) X $150,000 x 2 = $9,000

That is a lot of money and quite frankly doesn't pass the smell test in a lot of cases. Many broker based lenders that I deal with have much more reasonable penalty clauses to help you avoid this type of situation.  

Another great alternative to avoid this all together is to consider a variable rate mortgage (I currently have 5 year variable rate deals as low as Prime - 0.75% = 2.10%). If you pay out a 5 year variable deal early, the payment penalty is capped at 3 months interest based on the prime rate (currently 2.85%). Under the scenario we worked through, the penalty would be a much more reasonable figure of $1054.

If you are looking for proper financial advice (and a great rate) for your next mortgage, please give me a call as I would like the opportunity to earn your business.

#mortgagepenalties   #craignickerson