It’s easy to get caught in the posted mortgage rate trap at the big banks.No, you won’t have to pay the posted rate on your next mortgage. Pretty much nobody does that any more. The real danger is that posted rates will be used to calculate the penalty if you ever have to break your mortgage, probably costing you thousands of extra dollars.
A mortgage penalty compensates a lender for the interest payments it loses out on when you break a mortgage contract.
With houses as expensive as they are today, it’s crucial to get the lowest mortgage rate you can. Keep the same level of focus when inquiring about mortgage penalties. Although it’s hard to imagine the need to break a mortgage on a house you’re just buying or living in happily, it can happen.
Mortgage penalties are straightforward if you have a variable-rate mortgage – expect to pay the equivalent of three months’ interest in most cases. With a fixed-rate mortgage, the penalty is set at the higher of three months’ interest or a calculation called the interest rate differential, or IRD. The must-ask question when negotiating a fixed-rate mortgage: Do you use discounted or posted rates to calculate these penalties?
This is important because using posted rates can result in a much higher penalty. For some real world numbers, let’s use the mortgage prepayment calculators all now provide on their websites. They show penalties for paying all or a portion of your remaining mortgage balance (to find them, Google your lender’s name and “mortgage prepayment calculator”).
Let’s use an example of someone who, three years ago, set up a $250,000.00 five-year mortgage and has a balance owing of $200,000.00. Assuming an original mortgage rate of 3.64 per cent with a discount of 1.5 percentage points, the mortgage prepayment calculators at several big banks showed penalties ranging from $5,000.00 to $7,600.00 or so.
A check with some alternative lenders found penalties ranging from $1,800.00 to $2,800.00. These are very rough comparisons because lenders differ a fair bit in what information they ask you to supply. But you get the picture – the big banks apply penalties with a sledgehammer.
As well as producing revenue for lenders, inflated mortgage penalties also help trap clients who might otherwise move their business to another lender. Imagine you want to refinance your mortgage or buy a bigger home and your bank won’t come across with a competitive rate. You say you’ll change banks, only to find out how prohibitively expensive it is to break your mortgage.
Alternative lenders often have better rates than the big banks and they typically have cheaper penalty fees. Why do so many people use their banks for mortgages, then?
Some borrowers like the convenience of having their mortgage where they bank, and of being able to go into a branch to talk about their mortgage.
One thing you do not need to worry about if you borrow from an alternative financial institution is that your lender will go bankrupt. It’s funny that people look at mortgages and think, I need a safe lender. If a lender goes out of business, pretty much nothing is going to change except for the name of your new lender.