The 2 Types of Mortgage Penalty Calculations

General Pam Pikkert 31 Mar

 

 

We have all heard the horror stories about huge mortgage penalties.   Like the time your friend wanted to refinance her home so that she could open a small business only to find out that it was going to cost her a $13,000 penalty to break her mortgage.  This should not come as a surprise.  It would have been in the initial paperwork from the mortgage lender and seen again at the lawyer’s office.  A mortgage is a contract and when it is broken there is a penalty assessed and charged.  You will have agreed to this. The institution that lent the money did so with the expectation that they would see a return on that investment so when the contract is broken there is a penalty to protect their interests.  If you think about it, there is even a penalty to break a cell phone contract so the provider can recoup the costs they incurred so it stands to follow that of course there would be a penalty on a mortgage.

The terms of the penalty are clearly outlined in the mortgage approval which you will sign.   The onus is on you to ask questions and to make sure you are comfortable with the terms of the mortgage offer.  With so many mortgage lenders in Canada, you can very easily seek out other options if needed.

There are 2 ways the mortgage penalty can be calculated.

  1. 3 months interest – This is a very simple one to figure out. You take the interest portion of the mortgage payment and multiply it by 3.

For instance:  Mortgage balance of $300,000 at 2.79% = $693.48/month interest X 3 months or $2080.44 penalty.

OR

  1. The IRD or Interest Rate Differential – This is where things get trickier. The IRD is based on:
  • The amount you are pre-paying; and,
  • An interest rate that equals the difference between your original mortgage interest rate and the interest rate that the lender can charge today when re-lending the funds for the remaining term of the mortgage.

In Canada there is no one size fits all in how the IRD is calculated and it can vary greatly from lender to lender.  There can be a very big difference depending on the comparison rate that is used.  I have seen this vary from $2850 to $12,345 when all else was equal but the lender.

Things to note:

  • You will be assessed the GREATER of the 2 penalties.
  • You should always call your lender directly to get the penalty amount and do not rely on online calculators
  • You can avoid the penalty by porting the current mortgage if you are moving or waiting until the end of the term
  • A variable rate mortgage is usually accompanied by only the 3 month interest penalty

Given that 6/10 mortgages in Canada are broken around the 36 month mark, wouldn’t it be better to find out before you sign how your mortgage lender calculates their penalty just in case??

The New Realities about Mortgages

General Pam Pikkert 20 Mar

The New Real Realities about Mortgages

So the news has been full of a bunch of information about mortgage over the last few months and it can be very overwhelming to say the least.   We are going to take a look at the new reality of the mortgage landscape in Canada in an attempt to dispel some of the misconceptions.

  1. You can still buy a home with 5% down.   Many people seem to think this was changed but the truth of the matter is that yes, you can purchase a home with just 5% down.  The down payment can come from a variety of sources.
  • Savings/Stocks/Shares
  • Sale of an Asset
  • Tax Refund
  • RSP
  • Gift from an immediate family member
  • Borrowed from a secondary source such as a credit card, loan or line of credit

If you are buying a second home which will be used by a family member you can proceed with 5% down.  If you have purchased and sold before you can still proceed with 5% down.   You will of course pay the mortgage insurer fees each time you do so but it is good to know this option is still open to you.

  1. There is now a stress test interest rate in place. This is to make sure you will be able to afford your home when the rates start to climb.  You must qualify for the mortgage at the posted rate which is currently 4.64%.  The rate you will be offered is much lower than this but if you are trying to see how much home you qualify to purchase, this is the rate you need to use on the mortgage calculator.
  2. The longest you can take a mortgage over, in 99% of the cases, is 25 years. Yes, in the past we could look at 30, 35 or even 40 years but those days are gone.
  3. If you are considering a refinance of your home to invest, payout bills or for any other purpose, keep in mind that you can only go to 80% of the property’s value. For example, if your home is currently appraised at a value of $300,000, the maximum mortgage you can put in place would be $240,000.
  4. Mortgage Insurer fees have increased again as of March 17, 2017. This insurance premium is what allows the mortgage lenders to lend to people with less than 20% down.  If you default on your mortgage, the lender is assured they will not have any losses.
  5. The really pretty low rates you often see advertised are more likely to be offered to those putting less than 20% down. In October of 2016 the Federal Government made some changes whereby mortgage lenders could no longer insure all mortgages.  This was most often done at the expense of the lenders and was done to lower their overall risk on their mortgage portfolio.  In the new lending landscape, there is now less risk for lenders on insured mortgages and they are offering these clients some very attractive rates.  It is counter intuitive but those with a larger equity position are now higher risk.
  6. You need to have a strong financial picture to qualify for a mortgage. The lenders are looking for 2 years on 2 types of credit at a minimum.  These need to be paid on time and gone are the days where ‘I just forgot to pay’ as a valid response.   Ensure your bills are paid on time and that your credit cards do not exceed 50% of their limit.

 

There you have it, the new reality of mortgage in an attempt to dispel the myths and to let you know what is now possible.  As always, a qualified mortgage professional is your very best option for all things mortgage.