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Wednesday, July 27th, 2016

Why mortgage penalties are so hard to understand

By Peggy Mackenzie

If you want to break your mortgage, there are two ways to calculate the penalty. One uses three months’ interest and the other uses the Interest Rate Differential (IRD).  The bottom line is that with either method, if you want to take advantage of lower interest rates, it’s going to cost you. And it will be a mind-numbing exercise trying to understand the penalties.

I want to take advantage of an offer by the Royal Bank for a 2.99 per cent five-year mortgage. But to do so, I must break my existing $116,000 mortgage with PC Financial.

When the penalty is calculated using three months’ interest, the process is straightforward. Since $450 of my monthly payment goes towards interest each month, the cost is $450 times three months which is $1,350.  But when I use the Interest Rate Differential (IRD) method, the choice becomes difficult because the penalty is more and getting a straight answer on how the penalty is calculated is difficult.

An interest rate differential is the difference between the interest you would have paid over the balance of the mortgage, versus the new rate the bank can charge another client for the remainder of your term. If  interest rates fall, the bank increases your penalty because it can get less from that other client.  This so-called  “reinvestment rate”  is  blamed for the constantly changing penalties.  In my case, during the few days I was  asking questions my IRD penalty at PC grew by $90 because the reinvestment rate decreased.

PC calculated my penalty on the 21 months left on my mortgage as $4,019 or 200 per cent more than the three months’ fee.

It’s almost impossible to figure out the IRD.   Each bank follows its own formula so calculations differ. When I used the Royal Bank calculator , the IRD penalty dropped dramatically – just $2,878. The amount increased by almost $400, however, when I spoke to a RBC mortgage specialist. The calculator omitted the key reinvestment rate.

More terms bandied about when calculating the IRD are “posted” versus “discounted” rates but that’s a blog for another day. Suffice it to say, I’m more confused than ever. The only lesson I’ve learned during this exercise is to read your mortgage contract fine print and get a non-partisan expert to dumb it down for you.

Read also: Roseman: How to reduce the pain when you break a mortgage

My $3,900 mortgage penalty: How do they figure?

Contact Peggy Mackenzie at pmackenzie@thestar.ca or follow her on Twitter: @PeggyMackenzie

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