Bank of Canada Rate Hike
December 7, 2022Understanding mortgage prepayment penalties is crucial for any homeowner. In Canada, lenders typically calculate these penalties using either the 3-month interest penalty or the interest rate differential method, depending on the specific mortgage product and term.
The 3-month interest penalty is relatively straightforward. Lenders calculate it by multiplying the current mortgage principal by the current mortgage rate, dividing by 12 months to determine a monthly penalty, and then multiplying by 3 to cover three months. This type of penalty is commonly associated with variable-rate mortgages.
Conversely, lenders apply the interest rate differential penalty to fixed-rate mortgages. They calculate this penalty by determining the variance between the interest rate of the existing mortgage and the lender’s prevailing rate, multiplying this difference by the principal, dividing by 12 months to establish a monthly fee, and then multiplying by the remaining months in the term.
Let’s consider Louise, who holds a 5-year fixed-rate mortgage at 4.89% and intends to sell her property with 24 months remaining in her term. If the lender’s current rate stands at 3.5%, Louise’s interest rate differential penalty would be determined by subtracting 3.5% from 4.89%, resulting in 1.39%. This discrepancy is then multiplied by the principal amount of $200,000, divided by 12 months to yield a monthly fee of $266.67. Finally, this monthly fee is multiplied by the remaining term months (24) to yield a total penalty of $6,400.
It’s essential to recognize that lenders may vary prepayment penalties depending on the mortgage arrangement. Therefore, homeowners should understand the specifics of their mortgage agreement and be aware of their rights before contemplating any modifications to their mortgage terms. Speak to a mortgage broker to obtain all information in regards to penalties and fees involved with prepayments. For more information you can check out PrePayment Penalties
