Team Hayden | Shopping for a Mortgage: Bank vs. Non-Bank Penalty
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Shopping for a Mortgage: Bank vs. Non-Bank Penalty

When shopping for a mortgage, the majority of consumers ask one question, what is your best rate? True, some ask questions beyond rate (as they should) but not all do, so I’m going to help the majority look beyond rate. What if you obtained the lowest possible five year fixed rate on day one but two years later the penalty is ten’s of thousands of dollars? Did you really get a great deal? Let’s investigate

Let’s say you have a mortgage with a balance of $375,500 and a five year fixed interest rate of 3.49% (which you have had for the past two years). Let’s pretend, for whatever reason, you decide to break the term of your contract. Maybe the reason is to take advantage of today’s lower interest rates, debt consolidation, or selling the existing home.

A standard IRD (Interest Rate Differential) penalty would look like this:

  • Mortgage balance = $375,500
  • Your contract five year fixed interest rate = 3.49%
  • Number of years remaining on your term = three years
  • Current three year mortgage rate (term closest to the term remaining) = 2.89%

Standard IRD Penalty = A x C x (B-D)
$375,500 x 3 x (3.49% – 2.89%) = $6,759
Standard IRD Penalty is $6,759

Standard IRD penalties are typically offered by non-bank lenders, are available through the mortgage broker channel, and are significantly different from that of a big bank IRD penalty calculation. Let’s look at a ‘Big Bank’ IRD penalty (I won’t mention which bank this is, but they are all similar).

Bank IRD penalty calculation:

First, we must determine your ‘discount’. To do this, we must look back in time to when you first took out your mortgage 2 years ago. What was the posted rate? If you can’t remember, it should be posted on your original mortgage document. If you still can’t find it, I would suggest you consult your bank representative. That same mortgage document should be a break down of the mortgage penalty calculation, but if it doesn’t, you can find the break down below.

Step One: Find the discount

The bank’s five year fixed posted interest rate = 5.59% (this is the posted rate at the time you took your mortgage out and your bank can let you know what it is). Your contract five year fixed interest rate = 3.49% (this is the rate you were given).

5.59% – 3.49% = 2.1%

Your discount (the difference between the posted rate and your contract rate) is 2.1%.

Step Two: Choose the term closest to the term remaining 
To do this, visit your bank’s website to select the term and corresponding posted fixed rate. The bank’s five year fixed posted interest rate = 5.59% (this is the posted rate at the time you took your mortgage out and your bank can let you know what it is). Your contract five year fixed interest rate = 3.49% (this is the rate you were given).

5.59% – 3.49% = 2.1%

Your discount (the difference between the posted rate and your contract rate) is 2.1%.

Step Two: Choose the term closest to the term remaining
To do this, visit your bank’s website to select the term and corresponding posted fixed rate.

Step Three: The calculation

  • Mortgage balance = $375,500
  • Your contract five year fixed interest rate = 3.49%
  • Number of years remaining on your term = three years
  • Current three year mortgage rate (term closest to the term remaining)= 2.89%
  • Your discount (as determined above) = 2.1%
  • Current three year posted rate = 3.44%

Bank IRD penalty = A x C x (B-(F-E))
$375,500 x 3 x (3.49% – (3.44% – 2.1%))
$375,500 x 3 x  2.15% = $24,219.75
Your bank IRD penalty is = $24,219.75

What’s the average annual rate of interest, non-bank vs. big bank?

Bank

Average annual rate of interest: $375,500 x 3.49% = $13,104.95
IRD Penalty per year: $24,219.75 / 2 = $12,109.88

($13,104.95 + $12,109.88) / $375,500 = 6.72%

Average annual rate of interest: 6.72%

Non-bank

Average annual rate of interest: $375,500 x 3.49% = $13,104.95
IRD Penalty per year: $6,759 / 2 = $3,379.50

(13,104.95 + 3,379.50) / $375,500 = 4.39%

In the bank example, the lower the interest rate, the higher the discount. Which means the larger the penalty. Do your homework to avoid situations like this where your penalty can double, triple, or worse. It is estimated that between 60-70% of mortgage holders do not carry their mortgage to maturity. Make sure you are asking the right questions of your mortgage provider, bank, or broker. By virtue of the employee/employer relationship, it is difficult to receive unbiased advice from a big bank. My suggestion would be to speak with a mortgage broker, even if it’s for a second opinion.

Oh, and if dealing with a bank, ask the representative how they calculate their penalty. I bet they have no idea, which should be a red flag.

We are committed to helping Canadians save money and become mortgage free faster. To help you with asking the right questions, I have created a ‘Shopping Around’ questionnaire with five basic but very important questions.

If you are interested in learning more, I would encourage you to call us at 403.242.5547 or shoot me an email at jeremy@canadamortgagedirect.com.