It hasn’t always been like it is today. There was a day when the Mortgage Companies would charge you the future profit they would be missing out on if you broke your contract before the due date. Selling your home early, Refinancing to take out additional equity might be a few reasons for breaking a contract early. In recent years some lenders have changed how they calculate these so called penalties.
Knowing the bank’s rules and how they calculate a possible penalty could save you thousands of dollars.
Thus your mortgage broker partner will offer advice on more than just who holds the best or lowest interest rate in the market place. You will want to know “the fine print” and how it affects you going forward.
Everyone knows that some financial institutions advertise what is known as their “Posted” interest rates. These are typically displayed on websites or signage in store fronts. “Discounted” rates are what is offered to compete with the market place. Typically you must meet with an employee and do some negotiations to get your discount established. Here is where the huge discrepancy arises in the loss or penalty to their newly acquired clients.
Take a look at an example of what I am talking about:
Calculation Method #1 – Discounted
We calculate this by taking the “Actual” interest rate that you are paying now less the “Discounted” interest rate being offered for the remaining amount of time you have left in your original contract.
So If you were paying 4.2% originally and you have lets say 2 years left in your mortgage (with a 2 year mortgage today discounted to 2.6%) then the difference would be a net 1.6% on the current balance. You will read this difference stated as an interest rate differential in your mortgage documents. The difference in rate of course is a “per year” basis calculated for the remaining 2 years. Assume your balance is $200,000 left today after you pay down the allowed amount, then you would pay a penalty of approximately $3,200 per year or $6,400 to break this contract. (Values subject to small variations per lender)
** It is important you remember to take advantage of your annual 20% pay down before these calculations are done. This tip alone will save you several thousands of dollars.
Calculation Method #2 – Posted Rates
We calculate this method by taking the “Actual” interest rate you are paying now and finding out what discount from the lender’s originally “Posted” rate at the time you took out your mortgage. In our example above 4.2% is the discounted rate. A posted rate back when you started would of come in close to 5.90%. Therefore the discount given below the posted rate originally would have been 1.7%. Keep that number handy. Using this method we calculate the potential loss or differential for the current lender by taking what you are paying now less the difference between the “current posted rate for the remaining time in your term of the contract” and the “original discount amount” which was the 1.7%.
Difference this way would be the 4.2% (you are paying now) – ((2.9% (posted 2 year rate remaining term) – 1.7% original discount amount) for a final 3.0% difference amount. Again for the remaining balance of $200,000 x 3.0% or $6,000 per year times 2 would be a final pay out amount of around $12,000 in this example.
Almost double the amount charged by the mortgage company offering the same low introductory rate that you thought was so amazing. Buyer beware is what is comes down to. In my opinion it appears to be blind siding regular consumers into what can only be called a “stay with me or pay” tool. Oh and don’t forget about all of the added admin costs. A few hundred dollars here and there are to be expected.
I represented a client a few months back where the specific lender even disallowed ANY form of pay back because there wasn’t a sale of the property at that time. So there was no potential interest rate savings for that poor person. By the way I have refused to do any future business with that particular lender once I saw what was hidden in their “fine print”.
In closing I have seen discounts even rise to over 2.0% these days which would really add to the payout costs using the Posted Rate method. As well it is important to know that the lenders who use the better discounted method mostly use the mortgage broker channel to distribute their mortgages. All I can say is know your lender and know their fine print. Talk to your favorite mortgage broker and consider all of these items when choosing your lender.
All the best!