Your friends or family may have told you about how they were hit with a penalty when selling or refinancing. You may think that you don’t need to worry about this happening as you are purchasing your “forever home”. However, it is important to note that over 60% of Canadians break their mortgage about 38 months into a 5 year term. Penalties do vary between lenders as well as products. In a fixed rate, typically penalties are the greater of 3 months interest or Interest Rate Differential (IRD). A variable rate is typically limited to 3 months interest. Some institutions offer “no frill” mortgages where the penalties can be much different and in some cases you may not be able to get out of the mortgage unless you have an arms length sale on your home. Another very important point is the difference in penalties charged by banks vs monolines. Banks use posted rates to calculate their penalties whereas monolines do not have posted rates so the penalties are significantly lower. For example, if you had a mortgage balance of $300,000 today with a current rate of just 3.09%, the penalty from a bank would be approximately $11,875 and from a monoline it would be approximately $3,680. That’s a difference of over $8,000!
Penalties are charged by all institutions if you are in a closed mortgage (closed mortgages can be fixed or variable rates). If you pay your mortgage out prior to the end of the term you will be charged a penalty. If you are increasing your mortgage, whether it is to complete some home improvements or whether you are selling your home and upgrading to a more expensive one, you will also incur a penalty unless you have the ability to blend the rate and therefore avoid a penalty. (A blended rate is a calculation where the lender takes the rate that you currently have and blends it with their current rate based on the amount that you are increasing your mortgage by). Most lenders offer this option.
It is important that you understand the type of penalties you could be facing. Your mortgage professional will be able to explain this to you.