Mortgage Prepayment Penalties 

Why Are The Big Banks' Penalties So Much Higher? 

When getting a mortgage through us you’ve probably heard us say “rate is important, but the terms of your mortgage are equally important.” Prepayment penalties wouldn’t matter if they were small and no one ever paid off mortgages early. But they can be huge! Depending on your mortgage size and how early you’re paying it off, the penalty can amount to tens of thousands of dollars. You may think you have no intention of paying off your mortgage early, but things can change. You may inherit money or get a big raise. You may be forced to sell due to a growing family, divorce, or death in the family. Or you may simply want to refinance to get a lower rate. Any of these things can result in you paying a prepayment penalty. 

Most closed fixed-rate mortgages have a prepayment penalty of 3 months’ interest or the Interest Rate Differential (IRD), whichever is HIGHER. To calculate the IRD, the bank subtracts the mortgage rate you originally agreed to pay from the rate it can charge today, and then multiplies that by the amount you are prepaying. 

Why are the Big Banks Higher? 

An IRD was intended to ensure return on investment for those that provide funds for mortgages.  If you break your mortgage early, it pays the investor any interest they’ve lost.  That makes sense.  But the big banks have turned it into another way to overcharge clients.  To inflate the IRD, when a bank calculates your original interest rate they determine your discount from the posted rate on that term.  If you break your mortgage they then apply that same discount to your penalty formula. 

Big Bank vs. Other Mortgage Lenders 

One of the biggest reasons is how they calculate prepayment penalties when you break your fixed mortgage term.  Most monolines have MUCH lower posted rates so the discounts that inflate the pre penalties at the big banks don't apply.

Example:

If you got a 5-year fixed mortgage in February of 2020 for $350,000 at 2.99%.  Now you want to break it and the current balance is $325,000 with 2 years remaining. BMO has a posted rate on their 2-year term of 3.14%. MCAP has a 2-year term posted rate of 2.59%.  Here’s how those two lenders, one big bank and one monoline, would calculate your penalty: 

BMO: 

2.99 + 1.95 (the original discount you received off the posted rate) = 4.94%

(4.94% - 3.14%)/12 = 0.0015 Monthly IRD Factor

.0015 x $325,000 x 24 months remaining = $11,700* 

MCAP: 

(2.99% -2.59%) / 12 = .00033 Monthly IRD Factor

.0003333 x $325,000 x 24 months remaining = $2,600* 

That’s a $9,100 difference! * 

Assuming the posted rate for a 5 year term in Feb. 2020 at BMO was 4.94%.*   

At Ottawa Mortgage Shop, our job is not just to get you the best rate, but help you understand the other terms of your mortgage that can impact your overall mortgage costs.