Do banks charge penalties to break a mortgage?

Payout Penalties:
In this video, I’ll discuss payout penalties and the significant impact they can have on Canadian homeowners, aside from the mortgage rate, how a bank or lender calculates the cost to cancel a mortgage may be the single most important part of a mortgage contract. And I know this may sound boring, but if you have a mortgage or plan on having a mortgage in the future, I promise the next 100 seconds will be worth your time.

There are a few reasons why a homeowner may want to exit their contract early, such as to lower their rate or excess equity, but it’s also not uncommon to see this when they sell their house as well. For variable rate mortgages, the payout penalty is almost always three months of interest, regardless of the lender.

However, the calculation for fixed rate mortgage penalties can vary significantly, lender to lender, and that’s the point of the lesson. Let me explain.

A fixed rate mortgage penalty is usually the greater of three months of interest or an interest rate differential known as IRD. The interest rate differential is the difference between the interest rate on your current mortgage and the rate a lender would charge for a similar mortgage if you were to break the contract early.

Here’s what you want to know. Not all lenders calculate the IRD the same way. Big banks include the initial discount that they gave you off the posted rate when you signed up and worked this back into the IRD from day one. As a result, big banks can earn two to five times more from this calculation than monoline lenders or credit unions.

Big banks are key partners to brokers and offer valuable programs in the mortgage market. In some cases, a five-year fixed rate with a big bank could be the best option, but we generally recommend shorter terms and variable rates with big banks to avoid the potential issues related to the IRD.

In summary, stay informed and work with a professional who has your best interest in mind.

Video Highlights:

Understanding Payout Penalties in Mortgages
A breakdown of the significant impact payout penalties can have on Canadian homeowners, emphasizing why understanding these penalties is crucial when signing a mortgage contract.

Why Homeowners Break Their Mortgage Contracts
Homeowners may want to break their mortgage for various reasons, such as lowering their rate, accessing equity, or selling their home. Knowing the implications of breaking a mortgage early can save money in the long run.

Variable vs. Fixed-Rate Mortgage Penalties
While variable-rate mortgage penalties are typically straightforward (three months’ interest), fixed-rate mortgage penalties are more complex, varying significantly between lenders.


The Interest Rate Differential (IRD) Explained
An in-depth explanation of how the Interest Rate Differential (IRD) is calculated. The IRD determines the payout penalty on a fixed-rate mortgage, and not all lenders calculate it the same way.

Big Banks vs. Monoline Lenders: Payout Penalty Differences
A critical comparison between big banks and monoline lenders/credit unions. Big banks often charge higher penalties due to factoring in the initial discount given at the start of the mortgage, resulting in higher payouts when breaking the mortgage early.

Recommendations for Mortgage Terms
A recommendation to consider shorter terms or variable rates with big banks to avoid potential issues with large payout penalties.

Takeaways

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  • Payout penalties are a critical aspect of mortgage contracts and can significantly impact homeowners financially if they decide to break their mortgage early.
  • Variable-rate mortgages typically have straightforward penalties—three months of interest—regardless of the lender.
  • Fixed-rate mortgage penalties can vary widely, with the Interest Rate Differential (IRD) being a major factor. Not all lenders calculate the IRD the same way, and big banks tend to charge more.
  • Big banks often include the initial discount given on the mortgage when calculating penalties, which can lead to higher fees compared to monoline lenders or credit unions.
  • To avoid higher penalties, consider shorter terms or variable-rate mortgages when working with big banks.
  • Always work with a trusted mortgage professional who prioritizes your best interests and helps you navigate these complexities.
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