Historically-low interest rates have had many homeowners thinking about pulling off a “break and run.” This is a term coined in the mortgage industry that describes breaking your mortgage when the interest rate saving will be at least 2 – 3 per cent. And while this makes sense for many homeowners, breaking a mortgage is becoming more complicated by the day as lenders think of new ways to keep old clients; and you really need to know how much you’ll be paying in prepayment penalties overall.
Lots of people say (and we’ve been guilty of it on this blog) that the prepayment penalties you’ll be charged will be equivalent to about three months of interest payments on the mortgage. This is true, but it’s also a little too easy. The prepayment penalty for paying off a mortgage in Toronto early is based on the interest rate differential or rather, the IRD. This rate is based on the difference between your original mortgage interest rate and the rate that the lender could charge today for the same loan. However, it’s not always the IRD that’s used to calculate prepayment penalties. Sometimes, the lender will just take three month’s worth of interest – it will all depend on which number is the greater of the two.
So for example, Becky has $200,000 left on her mortgage balance; and because she took out her loan in 2007, the interest rate on that loan is currently at 5 per cent, with a 1.5 per cent discount on those posted rates (yes, any discount you received will also now be worked back into the equation.) Becky has 24 months left on her term. Because of this, her lender will use their closest comparison rate; today, that would probably be somewhere around 3.75 per cent for another two years.
Based on the fact that Becky’s currently paying 5 per cent interest on a $200,000 loan, three months of interest charges would be $2,500. However, when calculating the IRD between the current interest rates and the comparison rate, that shows a difference of $11,000 – and it’s this larger number that Becky would have to pay.
Remember that you cannot go strictly off this example alone, although it is a pretty good indicator of how to calculate your prepayment penalties should you break your mortgage. Because each lender has slightly different ways to break a mortgage and slightly different policies regarding the procedure, it’s always best to speak to a Toronto mortgage broker who can help first. They can even help you find a new mortgage if you’ll need one after breaking the loan you have currently.
