Bank of Canada Rate HikeDecember 7, 2022
Mortgage prepayment penalties can be confusing, and it’s essential to understand how they work. In Canada, prepayment penalties can be calculated using either the 3-month interest penalty or the interest rate differential method, depending on the mortgage product and term.
The 3-month interest penalty is a straightforward calculation that involves multiplying the current mortgage principal by the current mortgage rate, dividing by 12 months to get a monthly penalty, and then multiplying by 3 to account for three months. This penalty is typically applied to variable-rate mortgages.
On the other hand, the interest rate differential penalty is more complicated and is usually applied to fixed-rate mortgages. This penalty is calculated by finding the difference between the interest rate of the current mortgage and the lender’s current rate, multiplying the difference by the principal, dividing by 12 months to get a monthly fee, and then multiplying by the number of months remaining in the term.
For example, suppose Louise has a 5-year fixed-rate mortgage of 4.89% and decides to sell her house with 24 months left in her term. If the lender’s current rate is 3.5%, the interest rate differential penalty would be calculated by subtracting 3.5% from 4.89% to get 1.39%. This difference is then multiplied by the principal of $200,000 and divided by 12 months to get a monthly fee of $266.67. Finally, the monthly fee is multiplied by the number of months remaining in the term (24) to get a total penalty of $6,400.
It’s important to note that prepayment penalties can vary depending on the lender and mortgage product. Therefore, it’s crucial to understand the terms of your mortgage agreement and know your rights before making any changes to your mortgage.