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How Mortgage Penalties Work

When shopping for a mortgage, many of us search for the mortgage with the lowest rate. While that may be the best mortgage for you, that’s not always the case. In this article, we’ll look at something else to consider, mortgage penalties. We’ll review the mortgage penalties on variable rate and fixed-rate mortgages to help you decide the mortgage that’s right for you.


Variable Rate Mortgage Penalties

The mortgage penalties for variable-rate mortgages are pretty straightforward. You’ll almost always pay a penalty of three months of interest. This makes the penalties of variable-rate mortgages nice and predictable.

Let’s say you have a $500,000 mortgage, and you have to break it because you decide to move to a bigger home. If the current rate on your variable rate mortgage is 1.45 percent, then the three months of interest penalty would be about $1,800. 

Whether you break your mortgage one year in or four years in, the penalty will almost always only ever be three months of interest. While it’s true that your penalty could increase if your lender’s prime rate increases and, as a result, your variable mortgage rate goes up, you don’t have to worry about it ballooning to the same penalty size if it was a fixed-rate mortgage.

Keeping in mind with variable rate mortgages is that generally speaking, a variable rate mortgage is not portable. As such, if you need to move before the end of your mortgage term, your only choice will be to pay a mortgage penalty.

Fixed-Rate Mortgage Penalties: The Big Banks and Credit Unions

If you have a fixed rate penalty with one of the big banks, your mortgage penalty will be calculated as the greater of three months of interest and the interest rate differential (or IRD for short). The term “greater than” is key. The IRD is almost always greater than three months of interest. That’s because of the way that the big banks and credit unions calculate the IRD.

The banks and credit unions almost always use their inflated posted rate to calculate your mortgage penalty on the fixed-rate side. As a result, your penalty can be significantly higher. If the bank’s posted rate is near five percent, even if you received a sizable discount when you first signed up for your mortgage, your penalty can still end up being quite sizable.

Let’s say your fixed-rate penalty ends up being four percent of the outstanding balance. Then that would mean you’d need to pay a penalty of $20,000 to break your mortgage sooner.

Do you still think fixed-rate mortgages are safe? That’s why you should be extra careful when signing up for a fixed-rate mortgage and be certain you won’t be breaking it early.

Fixed-Rate Mortgage Penalties: Non-Bank Lenders

If you like the fixed payment and fixed rate of a fixed-rate mortgage, but you don’t like the costly penalties, there may be a way for you to have your financial cake and eat it, too.

It’s based on the lender’s discounted rate with non-bank lenders such as First National and MCAP instead of your penalty is based on the inflated posted. That makes a huge difference. Instead of your mortgage penalty being $20,000, it might only be $3,000 or $4,000, or it might only be three months of interest if rates are higher now than when you initially signed up for your mortgage.

That’s why it’s so important to understand mortgage penalties when you sign up for a mortgage, so you aren’t blindsided by them later on.

The Bottom Line

Are you trying to decide between a variable rate and a fixed-rate mortgage? Are you trying to weigh the pros and the cons? Let our experts help you. We can go over the numbers together and help you decide the right mortgage for you.

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