This is the second part of our blog discussion on mortgage penalties. Last time we looked at the 3-month (or less in some cases) interest penalty. Today, we will talk about the not so favourable Interest Rate Differential or IRD.
The IRD penalty is the “black sheep” in the mortgage world…Why?
Every lender seems to calculate it differently, they won’t tell you (or be able to) tell you how to calculate it, it’s not typically explained clearly in the mortgage contract, it’s not negotiable and finally it can cost you thousands of dollars!
Remember lenders will charge the HIGHER of either 3 months interest or the IRD penalty. Translation, In a declining interest rate environment you will likely pay an IRD penalty and in a flat to increasing interest rate market you will likely pay the 3 month penalty.
The theory is when you payout your mortgage to move it to another lender or refinance it at a lower mortgage rate the bank is losing future interest payments for the duration of your mortgage term. When you close your mortgage with them they will re-lend that money, but at a cheaper rate (the going market rate). This interest difference, or loss, is essentially the reason for the IRD penalty.
From the banks perspective you have signed a contact for a specific term in which they have secured the funds for and likely “sold off” your mortgage contract to investors who are looking for a reliable return. By breaking your mortgage, you have rocked their boat and they are will have to re-issue the money at a lower rate.
In a declining interest rate environment you will likely pay an IRD penalty
If the bank didn’t have any significant fees to paying off your mortgage, we as consumers would likely be switching from bank to bank every month when mortgage interest rates were declining to obtain a slightly better rate.
It’s always wise to get a FIRM penalty quote in writing based on the day you plan to payout the mortgage. Since rates and time periods change, you could be quoted one penalty today and a completely different one in a months time.
Next blog we will walk through some calculations to estimate how much the IRD penalty could be. We will wrap up this series by looking at a couple tricks to help minimize the penalty you have to pay.