When shopping for a mortgage, the majority of consumers ask one question, what is your best rate? True, some ask questions beyond rate, as they should, and today I’m going to help the majority look beyond rate. What if you obtained the lowest possible 5 year fixed rate on day one but two years later the penalty is ten’s of thousands of dollars? Did you really get a great deal? Let’s investigate…
Let’s take a mortgage balance of $400,000 and a 5 year fixed interest rate of 3.19%, which you have had for the past two years. And for whatever reason you have decided to break the term of your contract, maybe it’s to take advantage of today’s lower interest rates, debt consolidation, selling the existing home, etc…
A. Mortgage balance = $400,000
B. Your contract 5 year fixed interest rate = 3.19%
C. Number of years remaining on your term = 3 years
D. Current 3 year mortgage rate (term closest to the term remaining)= 2.79%
Standard IRD Penalty = A x C x (B-D)
$400,000 x 3 x (3.19% – 2.79%) = $4,800
Standard IRD Penalty is $4,800
Standard IRD penalties are typically offered by non-bank lenders available through the mortgage broker channel and are significantly different from that of a big bank IRD penalty calculation. Let’s look at the RBC IRD penalty.
First, we must determine your ‘discount’. To do this we must look back in time to when you first took out your mortgage 2 years ago…what was the posted rate? If you can’t remember, it should be posted on your original mortgage document. If you still can’t find it, I would suggest you consult your RBC representative. On the same mortgage document should be a break down of the mortgage penalty calculation, if not, I have included the link RBC calculation here.
The RBC 5 year fixed posted interest rate = 5.24%
Your contract 5 year fixed interest rate = 3.19%
5.24% – 3.19% = 2.05%
Your discount, the difference between the posted rate and your contract rate, is 2.05%.
To do this, visit the RBC website here to select the term and corresponding posted fixed rate.
A. Mortgage balance = $400,000
B. Your contract 5 year fixed interest rate = 3.19%
C. Number of years remaining on your term = 3 years
D. Current 3 year mortgage rate (term closest to the term remaining)= 2.79%
E. Your discount (as determined above) = 2.05%
F. Current 3 year posted rate = 3.80%
RBC IRD penalty = A x C x (B-(F-E))
$400,000 x 3 x (3.19% – (3.80% – 2.05%))
$400,000 x 3 x 1.44% = $17,280
Your RBC IRD penalty is = $17,280
RBC
Average annual rate of interest: $400,000 x 3.19% = $12,760
IRD Penalty per year: $17,280 / 2 = $8,640
($12,760 + $8,640) / $400,000 = 5.35%
Average annual rate of interest: 5.35%
Non-bank
Average annual rate of interest: $400,000 x 3.19% = $12,760
IRD Penalty per year: $4,800 / 2 = $2,400
(12,760 + 2,400) / $400,000 = 3.79%
Average annual rate of interest: 3.79%
In conclusion, when looking at the illustration, it is clear that in the RBC example, the lower the interest rate, the greater the discount, which means the larger the penalty. It is critical to do your homework to avoid a massive penalty shock. It is known in the industry that some where between 60% – 70% of mortgage holders do not carry their mortgage to maturity. Make sure you are asking the right questions of your mortgage provider, bank or broker. By virtue of the employee/employer relationship, it is difficult to receive unbiased advice from a big bank and my suggestion would be to speak with an independent mortgage broker, even if it’s for a second opinion.
Lastly, we are committed to helping Canadians save money and become mortgage free faster. To help you with asking the right questions, be sure to review my ‘5 Critical Questions to Ask Before You Get a Mortgage‘ form so you are better informed. If you are interested in learning more about our pro-active and ongoing mortgage management services, I would encourage you to call us at 403.242.5547.
