What happens if I need to break my mortgage term?
If a locked in mortgage term needs to be broken then there are typically 2 options; port the mortgage to a new home or, incur a breakage penalty.
What is Porting?
Porting is an option to move your existing mortgage (balance, rate, remaining amortization...) to a new home with NO breakage penalty. There is a time limit to port and the rules vary lender to lender. Porting does require re-qualifying with the lender and insurer.
NOTE: Typically only fixed rate mortgages can be ported.
So why doesn't everyone just port?
1) The #1 reason, because you can't change the amortization. So if you started with a 25year amortization and lived in that home for 7years; the maximum amortization on the new home would be 18years making it harder to qualify and if upgrading homes, a much larger payment.
2) If the client is concerned over rates increasing and wants to lock in for longer than their existing term.
3) If the lenders rules to port cannot be met. Example, possession of new home goes over days allowed.
4) You cannot port into a new construction home.
Why is there a penalty? Even if I don't want to port I will bring my new mortgage to the same lender, isn't that enough?
Sorry, but no. Fair is fair. I know if I were in a 5yr fixed term and 2years into it the lender called and said they changed their mind and were raising my rate, my next call would be to a lawyer. It goes both ways.
How are penalties calculated?
1) If you have a standard variable mortgage, typically the highest penalty that can be charged is 3 months interest.
2) If you have a standard fixed rate mortgage, it is typically the higher of:
a) 3 months interest or;
b) Interest Rate Differential (IRD)
IRD penalties calculate the difference between your contract rate and today's rate as well as the time you have left on your contract. IRD penalties can be substantial.
Calculating the IRD Penalty - Example
Step 1: Identify the outstanding balance on your mortgage. Step 2: Identify the annual interest rate on your mortgage. Step 3: Identify the current interest rate for the term closest to the remaining time left on your current term. Step 4: Subtract the answer found in step 2 from the answer found in step 3 to get the difference in interest rates. Write this interest rate as a decimal. For example, 2% = 0.02) 6% - 4%= 2% / .02. Step 5: Multiply the answer from step 4 by the outstanding balance on your mortgage in step 1 so 0.02 x $200,000 = $4,000. Step 6: Divide this answer by 12 months in a year to get the monthly interest differential. $4,000 / 12 = $333.33 . Step 7: Multiply this answer by the number of months left on the term. $333.33 x 36 mo's (example) = $12,000
Prepayment penalty estimate based on interest rate differential (IRD): $12,000
Calculating the 3 Month Interest Penalty - Example
Step 1: Identify the outstanding balance on your mortgage. Step 2: Multiply the outstanding balance on your mortgage by the annual interest rate on your mortgage. (Write the annual interest rate as a decimal. For example, 6% = 0.06) $200,000 x 0.06 = $12,000. Step 3: Divide the answer by 12 months in a year to get the monthly interest payable. $12,000 / 12 = $1,000. Step 4: Multiply the answer by 3 months. $1,000 x 3 = $3,000
Prepayment penalty estimate based on 3 months’ interest: $3,000
In the above example, the client would fall into an IRD Penalty of $12,000 (the higher of 3 months interest OR IRD). Now that we know this, we can have a deeper conversation on whether or not it is in their best interests to proceed.
Is there anything else I need to know about IRD penalties?
Yes, on top of the above lenders also have 2 ways of calculating the IRD penalty. One way, the client pays more; the other, the client pays less. This is something that Nikole reviews with you.
Are there any other charges I should be aware of?
Yes, all lenders charge approx. $300 as a discharge fee (sometimes a.k.a. a transfer fee or re-investment fee...) to cover their administration/costs involved.