HOW PREPAYMENT PENALTIES MAKE YOUR COST OF BORROWING MUCH HIGHER THAN YOU PERCEIVE

If you have ever been granted a mortgage, you are probably familiar with terms like Prepayment Penalty and APR, which is an abbreviation for Annual Percentage Rate.

To remind you, a prepayment penalty is applied when you end your mortgage agreement early, and the APR represents the annual cost of borrowing, including any fees or extra costs linked to your mortgage deal.

Statistics indicate that many borrowers do terminate their mortgage agreements early and incur prepayment penalties, which increase their overall borrowing costs. However, the expense of ending your mortgage agreement is not frequently addressed at the time of obtaining your mortgage approval.

Prepayment penalties vary depending on factors such as the length of the term, mortgage amount, interest rate, remaining time in the mortgage contract, type of mortgage (fixed or variable rate), and the specific lender. Unfortunately, there is no universal prepayment penalty that applies to all situations.

Canadian chartered banks often have expensive methods for calculating prepayment penalties on fixed-rate mortgages, which can burden consumers financially when trying to exit these contracts. In contrast, monoline lenders tend to use more favorable methods that can save you money if you exit early.

You may be wondering why Canadian banks are more expensive in this regard. Let me explain.

The Interest Rate Differential (IRD) calculation is used to determine penalties for fixed rate mortgages. The IRD measures the difference between your interest rate and the rate the bank can charge for a new mortgage of the same term, starting from the current date to the end of your original term. Big banks use "posted rates" – which are typically higher than the discounted rates they actually offer their customers - to calculate the IRD. This results in a much larger differential, and thus, the prepayment penalty is higher.

In contrast, monoline lenders (accessed through mortgage brokers), which specialize in mortgage lending only, use their discounted rate rather than some artificial posted rate. This tends to result in a much smaller prepayment penalty.

Therefore, when calculating your annual percentage rate, you must consider and factor in your potential (and likely) prepayment penalty and how your mortgage lender calculates it. In the end, prepayment penalties from Canadian Chartered Banks usually tend to amount to a much larger APR making the interest rate seem much less competitive when actually considered.

Do you have a question about your mortgage or exiting your existing mortgage? There are loopholes available to avoid having to pay prepayment penalties and I would be happy to discuss them with you.


Sarah Colucci, Mortgage Agent
Sherwood Mortgage Group, Broker 12176
Direct: (647) 773-4849
www.coluccimortgages.com



#mortgages #mortgagebroker #realestate #mortgageadvice #torontorealestate #mortgagetips #money #financialadvice #banks

RSS Feed