Are you selecting Best Mortgage Solution with Lower Penalty for Maximum Savings?
There are two types of mortgage. One is OPEN and second is CLOSED.
OPEN mortgage are Variable Open, Line of Credit (LOC) and Home equity line of credit (HELOC). There is NO PENALTY when using open mortgage but the rates are usually higher than that of closed mortgage.
CLOSED mortgage are Variable Closed and all FIXED term mortgages. With closed mortgages, there is PENALTY if you were to break the mortgage prior to an expiry term. There is difference in penalty for Variable closed and Fixed closed rate mortgage and thus, we will understand it individually.
Variable Closed mortgage is offered based on PRIME rate that is set by Bank of Canada. Financial Institution offers discount on PRIME based on market condition. The penalty when breaking variable closed mortgage is usually 3 months interest (could differ with some lenders if they are using Posted Rate or Contract Rate as Current Mortgage Rate). Lets consider a scenario of Mortgage of $300,000 taken for 5 year term with rate of PRIME - 0.50% (ie. 2.50%) and you are breaking the mortgage after 2.4 years, remaining mortgage is $250,000 and PRIME at that time is 5.00%
Please note that if lender is using Posted rate then the Posted rate as Current Mortgage Rate is determined at the time of breaking the mortgage.
Fixed Closed mortgage is offered based on fixed rate. Financial Institution determines fixed rate based on certain margin of Canada Bond Rate. The penalty when breaking fixed term mortgage is IRD (Interest Rate Differential) or 3 months interest whichever is higher. Lets consider a scenario of Mortgage of $300,000 taken for 5 year term from financial institution where posted rate is 6.00% and a discount of 1.50% is given to offer best rate of 4.50%. You are breaking the mortgage after 2.4 years with remaining term is 2.6 years, remaining mortgage is $250,000 and at that time the posted rate for 3 year remaining term is 3.50%.
Penalty for remaining term with Discount of Posted rates (BMO, CIBC, RBC, NBC, SCOTIA, TDCT, etc) :
IRD Penalty = Remaining Mortgage * Remaining Term * (Current Mortgage Rate - Remaining Term Rate + Discount Rate)
= $250,000 * 2.6 * (4.50% - 3.50% + 1.50%)
= $16,250
Penalty for remaining term with Best rates (i.e. discount is not applicable):
IRD Penalty = Remaining Mortgage * Remaining Term * (Current Mortgage Rate - Remaining Term Rate + Discount Rate)
= $250,000 * 2.6 * (4.50% - 3.50% + 0.00%)
= $6500
The above scenario helps you to see the bigger picture and how the penalty varies significantly with different financial institution. Please note the IRD penalty method used above is for illustration purpose only and actual method varies for each financial insitution to determine Remaining Term Rate, add back of Discount rate and restrictions. In closed mortgage, some financial institution will offer lower rates with restrictions (e.g. no portability, no pre-payment privilege, discounts on posted rates, etc) that will cost you much more in penalty when breaking the mortgage. Are you being aware of penalty method and restrictions behind the rates that could cost you much more in penalty and loose all your savings?
With current market situation and tightening of mortgage rules by Government of Canada (OSFI), we have access to 20+ big and small banks providing you the mortgage solution and flexibility that meet your personal needs. We are Mortgage Professionals to help you plan for home ownership (i.e. purchase, pre-approvals, cash back, renewals, renovations), provide step by step guidance to prepare for mortgage financing and implement personalized savings strategies to payoff mortgage sooner. There is no cost for our expert services and to seek for professional help you can CONTACT US.
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