Pre-Payment Penalties and Privileges

Is your mortgage adaptable to life's changes?

Mortgages come with various terms, and life's unpredictability might prompt you to:

Adjust your payment frequency
Increase or skip payments
Make lump sum payments towards your principal
Recast your mortgage after a significant payment to lower monthly obligations
Modify your mortgage terms, such as switching rate types, refinancing, or changing lenders
Pay off your mortgage entirely ahead of schedule

While having these options is beneficial, lenders often impose penalties to safeguard their interests when such changes occur.

Types of Mortgage Products:

Open-Term Mortgage: Offers maximum flexibility for payment adjustments, early payouts, or term changes, typically accompanied by higher variable rates.
Closed-Term Mortgage: Locks in your rate and term for a specified period (commonly five years), providing lower rates but with more restrictions and potential penalties. This is the preferred choice for most Canadian homeowners.
- Variable-Rate Mortgage: Generally entails lower pre-payment penalties but carries the risk of rate fluctuations.
- Fixed-Rate Mortgage: Provides rate stability but often comes with higher penalties for early repayment.
Many closed mortgages, whether variable or fixed, allow for certain pre-payment privileges, such as:
- Increasing Monthly Payments: Some lenders permit raising your monthly payment by a certain percentage, ranging from 5% up to 100%.
- Lump Sum Payments: Annually, lenders may allow lump sum payments towards your principal, typically between 5% to 20% of the original mortgage amount.
- Adjusting Payment Frequency: Switching from monthly to bi-weekly or accelerated bi-weekly payments can expedite principal reduction.
- Mortgage Recast: After substantial pre-payments, some lenders offer the option to recalculate your monthly payments based on the new principal balance.
It's essential to consult with your lender to understand your specific pre-payment options and any associated penalties.

Potential Pre-Payment Penalties:

If you decide to break your mortgage term early, make significant additional payments, or pay off your mortgage entirely before the term ends, you may incur penalties, including administrative fees.

Early Payoff Penalty: Often applies when paying off the entire mortgage before the term concludes, usually calculated as a percentage of the remaining principal.
Variable-Rate Mortgage Penalty: Typically involves a charge equivalent to three months' interest.
Fixed-Rate Mortgage Penalty: The greater of three months' interest or the Interest Rate Differential (IRD), which is calculated based on the difference between your original interest rate and the current rate, applied to the remaining term and principal.

Be cautious of mortgages with ultra-low rates, as they may come with restrictive conditions, such as bona-fide sale clauses, higher penalties for changes, or hidden fees.

Calculating the IRD Penalty:

Review Your Mortgage Details: Note your interest rate, remaining term, and outstanding balance.
Determine the Comparison Rate: Add 1.5% to your current rate to approximate the original posted rate. Find the current posted rate for a term matching your remaining period.
Calculate the Rate Difference: Subtract the current posted rate from your adjusted original rate to find the IRD.
Compute the Penalty: Multiply the IRD by the number of years left in your term and then by your remaining principal balance.

Note that IRD calculations can vary by lender, so it's advisable to consult your lender or a mortgage professional for an accurate assessment.

Navigating Mortgage Changes:

Life is unpredictable, and your mortgage should accommodate that. At Axe Mortgage, our experienced brokers can help you understand your mortgage terms, explore flexible options, and potentially find better solutions through refinancing or switching at renewal time.

Whether you're a first-time homebuyer or looking to adjust your current mortgage, we're here to provide expert advice and secure the best rates to help you save money and reduce stress.

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