How to Save on Mortgage Penalities (hypotheque)

Sometimes it’s even worse

For the most part, for fixed loans, the early payment penalty is the higher of three months interest, or the differential between the original interest and new rates of interest, for the remainder of the life of the loan.

BUT… it is not always that simple.

There are lenders, including the large mortgage lenders, who choose to calculate the rate difference in the way that is most beneficial to them, sort of creative financing. Rather than using the discounted rate that they used on the original loan, they will use the posted rate, which is usually the highest mortgage rate. This is why it is very important to get an estimate on prepayment penalties from your lender.

(NOTE: We want to let you know about this so that you know to be careful and be sure to choose a good lender. Working with an experienced broker can help you place your mortgage application with a lender who uses the best penalty result for you.

Different penalties for different products:

Each kind of loan products have, in general, different penalties:

· Open Mortgage Loan: this is the only kind of loan that does not have a penalty for pre- payment. The various types of “line of credit” mortgages are often open mortgages.
· Fixed closed mortgage loan: For the most part, the penalty is calculated as the higher of either three months interest or the differential between the original rate and the current rate, for the rest of the term of the loan.
· Fixed closed long term mortgage: Home loans that have maturities of over 15 years
o For the initial five years of the loan period, is the higher of either three months interest or the differential between the negotiated rate and the current rate, for the rest of the loan period.
o After five years, it is only three months interest.
· Variable closed mortgage loan: As a rule, three months interest ; however some lenders only charge two months interest and there are others who may charge as much as six months interest for a penalty.
· Mortgage loan “5 in 1”: This is offered by some mortgage lenders. The penalty is usually 6 months interest.

Reimbursement of cash rebate

Certain mortgage loans include a cash rebate. Of course, the rate is higher and you must reimburse the amount of the cash rebate equal to the number of months between the time you break the home loan contract and the end of the mortgage term.

Example: Your home loan included a cash rebate of 4% of your mortgage for $200,000, or $8,000. If you repay the mortgage after 30 months (instead of the 60 months for a 5 year mortgage), you have to repay a certain portion of this cash rebate. In this case, it is calculated at 31/60th of the whole amount, which represents the 31 months difference between the 30th payment and the 60th payment. Therefore, $8,000 X 31, ÷ 60 = $4,133.33, which will be the amount of the reimbursement of the cash rebate.

Of course, this refund will be added to any other penalties, and so your total penalties will be that much more expensive.

Why is there an early payment penalty to begin with?

In the world of mortgages, very few banks hold onto the loans they make. They continue to administer the loan, but they sell the loans in the secondary mortgage market to investors, who buy these mortgages in lots of $100 to $500 million. These investors plan on earning the interest on the loan for the remainder of the term.

If a mortgage is paid down before the term is over, regardless of how little time is left on the loan, the lending bank will have to take care of the contract changes as well as pay off the lenders for the amount of future revenue they are not going to earn now that the loan is paid off. These additional charges are not absorbed by the bank, but are passed onto the borrower in the form of charges and penalties.

Another reason is that lenders want to induce their clients to stay with them. This is a method for them not to lose clients.