Jason Peatz – Mortgage Associate

Mortgage Payout Penalties

February 3, 2010 2:59 pm Jason Book, Case Study, Employed Persons, First Time Home Buyer, Interest Rates

Closed mortgages offer great rates and typically fit most people’s needs.  Most people feel that they can stick to the term of the mortgage they have chosen.  But like a wise man once said – life is what happens while you were making other plans.

Things happen – divorce, your job is moved to another city – your needs change.  This is ok.  Lenders will allow people to get out of mortgages that they have gotten themselves into – for a fee of course.

These fees are called Pay Out Penalties.

Pay out penalties are typically determined in two different ways:

-          Interest Rate Differential

-          Three Months Interest

Lenders take whichever of the two is greater.

The Alberta Mortgage Broker Association defines the how these are calculated as follows:

“You can calculate these two penalty amounts using the simple interest formula to five a borrower an approximation of the cost:

I = P x R x T”

I = Interest

P= Principal

R = Rate

T = Time

For the three month interest calculation the formula would look as follows:

I = Current Mortgage Balance x Original Mortgage Interest Rate x 3/12 (Since time is in years we only want to calculate 3 months)

So if you have a mortgage of $150k at a rate of 7.5% the calculation to determine 3 months interest would give us a value of $2812.50.

For the Interest Rate Differential calculation the formula would look as follows:

I = Current Mortgage Balance x (Original Mortgage Interest Rate – Current Mortgage Interest Rate) x Time remaining in contract

So if you have the same scenario as above and the current mortgage Interest Rate is 6% and you have 3 years left in the term the calculation to determine the Interest Rate Differential would give us a value of $6750.

In this case the lender would charge you $6750 for leaving this mortgage.

What I believe is important to note in this case are:

-          The lender is not picking a number out of the air – there is a clear formula that they use.

-          People need to know what the consequences are.  This allows people to make educated decisions and educated decisions are good decisions.

If you have any questions regarding this please do not hesitate to contact me or another qualified Mortgage Broker.