Banks use two main formulas to calculate the penalties. First, they use the 3-month interest formula and second, the interest rate differential, or IRD.
Mortgage Penalty Calculations
Let me explain to you how bank calculates your Mortgage Break Penalty…
So let’s assume that you have a $400,000 mortgage and you took a 5-year term.
Let’s also assume that you have three years left on your mortgage when you break your mortgage. So, how do I calculate the penalties on closed mortgages? First, if you have a variable rate mortgage at 2.5% the calculation is only the three months interest penalty.
“If you have a variable rate mortgage, the penalty is only three months interest”
So, you take your balance, you multiply it by your current rate and then you multiply it again by 3 months divided by 12 in a year. That’ll give you a penalty of $2500. If you have a fixed rate penalty, let’s assume at a rate of 3.1%, it will be the higher of the two calculations.
“If you have a fixed rate mortgage, the penalty is the higher of three months interest and the Interest Rate Differential Calculation”
So, on the interest rate side, you take your current rate of 3.1% less the three-year rate of the bank that you chose, 2.6%, you create a difference of 0.5%. Now you take your balance times the months remaining, in this case, it’s 36 months, times the IRD, divided by 12, and that will create a penalty of $6,000.
Some other banks use a different calculation method. They take the three-year rate, the 2.6%, and then subtract the discount received of 1.5%. Now they take this calculation of 1.1 and they subtract it from your current 3.1% rate, creating a higher IRD or higher differential of 2%.
“Be very careful when the bank uses posted rates to calculate your Interest Rate Differential or IRD. This is the factor that multiplies a penalty, this is how $6,000 becomes $24,000”
Now, you take your mortgage balance of $400,000 times your months remaining of 36 months, times the higher IRD of 2%, divided by 12 creating a $24,000 penalty. Be very careful with the penalty break structure of your bank.
Brought to you, again, by MortgagesLab.
Mortgage Penalty Calculator Menu
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