All about Mortgage Penalities (hypotheque)

It can be even worse

In most cases, 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 rest of the life of the loan.

BUT… it is not always that simple.

Some lenders (even the large financial institutions) will instead choose to calculate the difference between the two rates for the end of the term of the loan in a rather interesting way. They decide to use the posted rate, usually the highest mortgage rate rather than the discounted rate. This is why you should always ask your lender for a penalty payment estimate.

(NOTE: We want to inform you of 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 calculation for you.

There are different ways of figuring the penalty, depending upon the product:

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

· Open Mortgage Loan: this is the only kind of loan that does not include 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 figured as the higher of either three months interest or the difference between the original rate and the current rate, for the rest of the term of the loan.
· Fixed closed long term mortgage: For mortgages of over 15 years, the penalty for
o For the first five years of the term, is the higher of either three months interest or the difference between the loan rate and the current rate, for the rest of the term of the loan.
o After five years, it is only three months interest.
· Variable closed mortgage loan: Normally, three months interest but sometimes certain lenders only charge 2 months interest and others will charge 6 months interest as a penalty.
· Mortgage loan “5 in 1”: This is popular among some mortgage lenders. The penalty is usually 6 months interest.

Reimbursement of cash rebate

There are some mortgage loans that include a cash rebate. In these cases, don’t be surprised that the rate is higher and that you must pay back the cash rebate equal to the number of months from the time you break the contract to the completion of the original mortgage term.

Example: You have received a cash rebate of 4% of your mortgage of $200,000, that is, $8,000. You repay the mortgage thirty months later (on a mortgage term of 5 years, or 60 months). You must repay 31/60ths of the rebate (there are 31 months between the 30th payment and the 60th payment on a total term of 60 months). The calculation is $8,000 times 31, divided by 60, or $4,133.33, to arrive at the amount of the reimbursement of the cash rebate.

You can be sure that this refund will be in addition to any other penalties, and so your total penalties will be that much more expensive.

Why is there a penalty for pre-payment?

In the world of mortgages, very few banks hold onto the loans they make. They continue to administer the loan, but they market 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, no matter 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 important reason that banks impose early payment penalties is that they want to discourage borrowers from leaving them. If it were free, borrowers would just switch lenders any time they wanted.

Gregory is an Accredited Mortgage Professional (AMP). To get more information on mortgage rates - taux hypothèque, please visit: Hypothèques - Mortgage Intelligence