Thinking of leaving your mortgage early…it may cost you more than 3 months interest…
Interest Rate Differential (IRD)
The IRD is a compensation charge that may apply if you pay off your mortgage prior to the maturity date, or pay the mortgage principal down beyond the amount of your prepayment privileges. The IRD is based on:
- The amount you are pre-paying; and,
- An interest rate that equals the difference between your original mortgage interest rate and the interest rate that the lender can charge today when re-lending the funds for the remaining term of the mortgage.
Most closed fixed-rate mortgages have a prepayment penalty that is the higher of 3-months interest or the IRD. Most variable-rate mortgages do not have IRD penalties.
The “Comparison Rate” is the lender’s rate for the term most closely matching your remaining term. For example, if you have 22 months remaining, it is common for lenders to use the posted rate of their 2-year term as the comparison rate. Things to note…
- Each lender has its own formula for calculating penalties.
- Some lenders do not use the discount you received in their calculation, which decreases the IRD and can lower your penalty considerably.
- When determining the comparison rate, some lenders round up your remaining months to the next longest term. Some round down.
- The Interest Act prohibits IRD penalties on terms over 5 years, after five years has elapsed. In such cases, a maximum 3-month interest penalty may apply. For example, someone who has been in a 6-year mortgage for 60 months or more would pay a 3-month interest penalty (maximum) to break it before maturity.
- A small number of lenders prohibit breaking a mortgage early—regardless of the penalty—unless in the case of an approved bona fide sale.
- The moral: Always contact your lender directly for an exact penalty quote.
Feel free to contact me with any mortgage questions.