Getting a mortgage can sometimes be easier than getting out of one.
You’ve taken on a mortgage and have property to call your own. But that’s not where the story ends.
Traditional wisdom says you should pay off any debt as quickly as possible because you could save thousands just from the interest alone. However, mortgages function differently from other consumer debt.
Let’s say that you, as a homeowner have accepted a job in another province and are required to move. In such a case, it may be in your interest to pay off your mortgage (if possible) or close the mortgage altogether. However, it’s often easier to get a mortgage than it is to get out of one.
Should a mortgage holder wish to pay off their debt early, the lender often charges some form of mortgage penalty.
Types of penalties
The types of penalties for paying off a mortgage early vary from lender to lender. Consult with your bank or mortgage lender to pinpoint the specific penalty for paying off your mortgage ahead of schedule. But there are two primary types of penalties, and the higher amount is usually the one that applies.
The first type is the simplest: three months’ interest on your current mortgage. This is usually the penalty for anyone with a variable rate mortgage or a fixed rate mortgage that’s more than five years into its term, of five years or more.
For example, let’s say you have a $300,000 mortgage with a variable interest rate of 2.5 per cent annually. Three months’ interest works out to be 0.625 per cent, which you multiply by the balance of $300,000. The total penalty works out to be $1,875. Easy, right?
The second type of penalty is much more complicated. In an interest rate differential penalty, often used for fixed rate mortgages, the lender calculates how much it would cost to lend the mortgage amount today and compares that amount to how much it cost to originally lend the money to you. The price you pay is the difference between the two amounts.
Lenders use a complicated formula to come up with this amount, which is often hefty (usually a few thousand dollars). But this is the price you pay for breaking a contract with your financial institution. Some mortgage planners can help lower that bloated number, but it’s best to know the price of breaking the contract before you ever sign it.
On top of either type of penalty for closing your mortgage, you’ll also pay a number of fees that vary based on your financial institution. Some of the more common fees include administration fees, pro-rated cash back and any discounts or benefits you received on your initial mortgage rate.