Prepayment Penalty

Mortgage Prepayment Penalty

Paying down your principal balance quicker than your mortgage agreements allows or adjusting your mortgage to reflect better rates before your renewal may seem like a great idea, but it may come at a cost.

Depending on your mortgage agreement, you may face hefty prepayment penalties by breaking your mortgage contract.

Womp Womp!

This is one of the great reasons why working alongside a licensed mortgage broker can significantly benefit your mortgage flexibility.

As a licensed mortgage broker, I'm well-versed with countless mortgage programs and solutions which allow me to help my clients (that's you!) plan for their future and avoid or mitigate prepayment penalties when possible.

I'll assess your current lifestyle vs. your expected lifestyle to paint a better picture regarding what type of mortgage solution may allow you to avoid paying a prepayment penalty.

What Is A Prepayment Penalty?

Prepayment penalties are a protection lenders use to mitigate their cost of lending.

Lenders charge interest (fixed rates and variable rates) on mortgages; when mortgages are approved, they're done so with the expectation that the lenders will receive a certain financial return.

Borrowers sometimes encounter situations which allow them to pay down their mortgage quicker - in some cases, lenders charge prepayment penalties to allow the borrower the flexibility while still receiving their expected income from the mortgage.

Let's take a look at some of the reasons a prepayment penalty may be charged below!

Life Is Constantly Evolving

If life remained static, we’d all know exactly what to plan and budget for…

…but as we all know, life can be hectic and unexpected changes happen everyday!

These changes may cause you to consider breaking/restructuring your mortgage before your renewal (potentially triggering a prepayment penalty):

• You’ve received a sizeable monetary inheritance
• You’ve been promoted to a higher paying role, providing you with more expendable monthly income to filter towards your mortgage
• You’ve won the lottery (lucky you!)
• You'd like to take advantage of significantly lower interest rates
• You're purchasing a new home and are planning to move

Keep in mind though that because lenders are expecting a certain return on their loan, they sometimes charge pre-payment penalties in order to protect their financial interests.

Certain mortgage solutions are offered which allow borrowers added flexibility to make payments towards their mortgage without prepayment penalties.

Mortgage Options Which Impact Prepayment Penalties

Choosing and open vs. closed term mortgage has a great influence over whether you'll be charged prepayment penalties for paying down your mortgage quicker than your mortgage agreement allows.

Open Mortgage
Open term mortgages are an attractive option if you believe you may experience significant life changes in the near future.

An open-term mortgage offers more payment flexibility. With an open-term mortgage you can pre-pay a portion (or the entire balance) off without facing pre-payment penalties.

So why wouldn’t everyone have an open-term mortgage?

Because flexibility comes at a cost (usually with a higher interest rate)!

Closed Mortgages
A closed-term mortgage generally offers lower rates but with less flexibility and higher prepayment penalties.

Depending on the lender, a closed-term mortgage may include a set number of allowable lump-sum payments which don’t involve prepayment penalties (called a ‘prepayment privilege').

The Importance Of A Prepayment PRIVILEGE

You deserve flexibility within your mortgage agreement, which is why the Financial Consumer Agency of Canada (FCAC) has outlined guidelines for lenders to follow, such as offering prepayment privileges.

Prepayment privileges are exceptions for amounts you can put towards your mortgage in addition to your regular payments.

With prepayment privileges, you may be able to do the following without a prepayment penalty:

• Make an additional lump-sum payment on your mortgage
• Increase your payment schedule
• Increase your payment amount up to a certain percentage

Not sure whether your lender allows prepayment privileges?

Connect with a licensed mortgage broker (such as myself) for guidance to find out whether your mortgage agreement allows for prepayment privileges - it could save you money!

How A Prepayment Penalty Is Often Calculated

Prepayment penalties vary from lender to lender and may be based on varying factors:

• How much of your mortgage you would like to pay down (if providing a lump sum payment)
• How far away the end of your mortgage term is (your renewal date)
• Your fixed or variable interest rate
• Your employment history
• The type of method which your lender uses to calculate a prepayment penalty

Generally, your prepayment penalty will be whichever is HIGHER between the:

1. Interest rate differential (IRD)
2. 3 months’ interest on your remaining balance

Your mortgage contract will stipulate which type of prepayment penalty you may face for making changes to your mortgage before you renew.

If you’d like assistance understanding your prepayment penalties, I'm here for you!

What Is An Interest Rate Differential, Or 'IRD'?

The interest rate differential is equal to the difference between the interest rate from your original mortgage agreement vs. 'todays rate' (AKA the rate your lender would charge 'today' to a borrower).

For determining a prepayment penalty using the Interest Rate Differntial, lenders may calculate it the following way:

1. The lender calculates the amount of interest owing for your current mortgage term using the posted rate from when you ORIGINALLY signed your current mortgage agreement
2. The lender calculates the amount of interest you have left to pay on your current mortgage term using CURRENT posted rates
3. The lender calculates the difference between steps one and two, providing them with the Interest Rate Differential (IRD)

Note: These calculations are a generalized guideline and may differ from lender to lender when determining prepayment penalties. It's always best to check with your specific lender to learn about accurate information regarding your prepayment penalties, or seek the help of a trusted licensed mortgage broker.

Tips For Mitigating Prepayment Penalties

Nobody enjoys extra fees or prepayment penalties.

If prepayment penalties seem like they'll do more financial harm than good, there are alternative solutions available.

• Be aware of AND make full use of prepayment privileges. They’re there to help you out!
• Wait it out; many mortgages have a term of 5 years or less. Connecting with myself (your trusted licensed mortgage broker) to learn about how much longer you’re committed to your term. Consider making a large lump-sum payment at your renewal date instead
• 'Port' your mortgage; this solution is sometimes available to homeowners who are moving into a new property and would like to 'take their mortgage with them' without facing prepayment penalties

Don’t Get Caught In Mortgage Handcuffs

There are few worse feelings than not being satisfied with your mortgage agreement, especially if you feel 'handcuffed' to it for years to come.

When it comes to prepayment penalties, sometimes you can't avoid them. But with proper planning for the future, your chances of dodging prepayment penalties may be increased.

I’m Kyle Benzies (licensed mortgage broker); my expertise within the borrowing industry will help shape your mortgage agreement into one you’ll be stoked to tell your friends about. I work with complete integrity and transparency to ensure you receive the best mortgage deal perfectly fit to YOU!

Let’s connect by phone or email for a (no-risk) chat to discuss prepayment penalties and your mortgage options!

***other conditions may apply to anything listed above. The information provided on this page should NOT be implicitly relied upon, and may not be 100% up to date. It's best to contact us for the most current conditions/program offerings for first time buyers***