Mortgage Payout Penalties
Your friends or family may have told you about how they were hit with a payout penalty when selling or refinancing. You may think that you don’t need to worry about this happening as you are purchasing your “forever home”.
However, it is important to note that on average – over 60% of Canadians break their mortgage 38 months into a 5 year term and are charged a payout penalty to do so. Payout penalties as referred to by lenders, do vary between financial institutions as well as products. In a fixed rate, typically penalties are the greater of 3 months interest or Interest Rate Differential (IRD).
A variable rate is typically limited to a 3 months interest penalty. Some institutions offer “no frill” mortgages where the payout penalties can be much different and in some cases you may not be able to get out of the mortgage unless you have an arms length sale on your home.
Another very important point is the difference in payout penalties charged by banks vs monolines. (Monolines, are institiutions that only focus on one line of business – mortgages. They don’t cross-sell you on other products such as bank accounts, insurance, credit cards etc…) Banks use posted rates to calculate their payout penalties whereas monolines do not have posted rates so the payout penalties are significantly lower. For example, if you had a mortgage balance of $300,000 today with a current rate of just 3.09%, the penalty from a bank would be
For example, if you had a mortgage balance of $300,000 today with a current rate of just 3.09%, the penalty from a bank would be approximately $11,875 and from a monoline the penalty would be approximately $3,680. That’s a difference of over $8,000! Payout penalties are charged by all institutions if you are in a closed mortgage (closed mortgages can be fixed or variable rates). If you pay your mortgage out prior to the end of the term you will be charged a payout penalty.
If you are increasing your mortgage, whether it is to complete some home improvements or whether you are selling your home and upgrading to a more expensive one, you will also incur a payout penalty unless you have the ability to blend the rate and therefore avoid a payout penalty. (A blended rate is a calculation where the lender takes the rate that you currently have and blends it with their current rate based on the amount that you are increasing your mortgage by).
Most lenders offer this option. It is important that you understand the type of payout penalties you could be facing. Your mortgage professional will be able to explain this to you.