Do You Know How Banks Calculate Mortgage Penalties ?

Recently, one of my clients brother called me and asked me how can he break his current mortgage and have new mortgage at lower rate ?

I asked him to contact his bank and get estimate of penalty as per the standard mortgage terms.

Here are some general calculation usally banks apply in case of mortgage term break before maturity.

 

There are usually 2 methods are used to calculate penalty,

Three months interest penalty or  Interest Rate Differential(IRD), whichever is high 

Let's see if someone has $100000 mortgage remaining at 4 % on a 5 year term mortgage. Assume that current posted rate is 5.30 % and you just paid 36 months installment.

Here I have shown calculations using nominal rate (as opposed to the effective rate) to assist you understand calculation.

Three-Months' Interest Penalty

(Annual Interest Rate x Balance Outstanding) ÷ 4
(0.04 x $100000)÷ 4 = $1000

Interest Rate Differential

Existing Mortgage Rate = 4 %

Current Posted Mortgage rate = 5.3 % 

Interest Rate Difference = 5..3 -4.0 = 1.3 % 

Interest Differential Penalty Estimate:

Nominal Rate x Balance Outstanding x Number of Years Remaining
0.013 x $100000 x 2 = $2600

In above example bank is going to charge $2600 as penalty for breaking mortgage after 36 months(3 years).