How to get out of a mortgage without a penalty.

If you break your mortgage early and are in a closed mortgage, you may have to pay a prepayment penalty. Depending on the financial institution your mortgage is with, the penalty may be quite substantial. 

Variable rate mortgages cost 3 months of interest to break. Fixed-rate mortgage penalties get calculated differently. 

“Fixed rate” prepayment penalties are based on the IRD, which stands for Interest Rate Differential. IRD is basically the difference between two interest rates. When calculating your mortgage penalty on a fixed-rate mortgage, the bank will basically subtract the discount you received on the original interest rate from the current posted rate for the term left in your mortgage. 

For example, let’s assume you have a $300,000 mortgage balance. Your interest rate is 5.49%. Let’s also assume you have approximately 3 years left in your mortgage term or about 35 months. Now, we will look at the lender’s three year posted rate as of today. It’s 3.89%. The interest rate differential is calculated by taking your interest rate of 5.49% and subtracting the current posted rate, which is 1.60%. Next, we would multiply the difference in interest rates (1.60%) by the principal balance left ($300,000) and divide by 12 months. This gives us $400. Next, we would multiply $400 by the 35 months remaining, which gives us $14,000 in penalties. 

Major banks use an inflated posted rate (the Bank of Canada’s posted rates), which make their penalties when exiting fixed-rate mortgages higher. 

Remember, penalties get charged to compensate the lender for the unexpected loss in profits that it would have received should you have stayed the entire term. So, it’s important to understand the risks associated with prepayment penalties before you sign a mortgage contract. 

How to get out of paying a mortgage penalty?

First, before you sell or refinance, find out what your penalty will be. You can call your mortgage holder and ask about the approximate penalty and whether you can use any prepayment privileges to lower the prepayment charge. By doing this, you can determine the total costs of breaking your mortgage and weigh out whether it makes financial sense.
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Second, you can ask your mortgage holder about porting your mortgage over to the new property if you are selling or blending and extending if you are refinancing.

​Blending and extending basically means blending the current rate with the rate you have, and increasing the mortgage balance. If you “blend and extend”, you won’t have to pay a penalty. Not all mortgage lenders offer this option but it’s best to inquire. 
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The other option is to wait until the IRD is less and the posted rates change so that you won’t have to pay a substantial penalty. 

Do you have questions about avoiding a mortgage penalty? Please call or write. 

Sarah A. Colucci, Mortgage Agent Lic. M14000929
Mortgage Edge, Broker 10680
Direct: (647) 773-4849
Email: sarah.colucci@mortgageedge.ca 

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