Mortgage Penalty Primer:
Mortgage penalties are fees that you may have to pay if you break your mortgage contract before the end of your term. The amount of the penalty depends on whether you have a fixed or variable rate mortgage, and how much time is left in your term. For variable rate mortgages, the penalty is usually equal to three months’ interest. For fixed rate mortgages, the penalty is usually the higher of three months’ interest or the interest rate differential (IRD), which is the difference between your rate and the current market rate.
If you have a fixed-rate mortgage and you want to pay it off early or switch to another lender, you may have to pay a mortgage penalty. This is a fee that your lender charges to compensate for the lost interest revenue. One way to calculate this penalty is by using the interest rate differential (IRD) method. The IRD is the difference between your original mortgage rate and the current rate that your lender offers for a similar mortgage. However, the big banks have found ways to increase the IRD number in their favour. Learning about the calculation can help you in the future. The IRD penalty can be very expensive, depending on how much you owe and how long your term is. Therefore, it’s important to understand how your lender calculates the IRD and what options you have to reduce or avoid it.
This video below will help illustrate the math that goes into IRD and why it can add up to big numbers. It also demostrates how the math is different between banks, credit unions and monoline lenders.