Understanding How Mortgage Penalties Work

| July 8, 2014

how Mortgage penalties workMortgage penalties are an important part of any mortgage agreement, but many homeowners only find out about how Mortgage penalties work when they have to pay them. Shopping for a mortgage should always include the best possible scenario for the homeowner based on their future needs.

For instance, if a home buyer knows that they will not stay in their new home for many years. They will want to make sure they are able to break the contract with the mortgage company to do so.

Most mortgages are considered “locked-in” until the end of the entire term of the mortgage unless a penalty to paid to the lender.

Lenders Want To Protect Themselves

No one wants to pay a penalty, but mortgages include them for a reason. Lenders want to recoup some of the interest that will be lost when a homeowner pays off the contract before the end of the original agreement. While this sounds reasonable enough, in reality the penalties are often substantial. In some cases have little to do with recouping unearned interest.

Many lenders include large penalties in their agreements to discourage homeowners from taking their business elsewhere. If the homeowner buys another home and they want a new mortgage, some lenders will only waive the penalty if the new mortgage is with them too. Other mortgage contracts cannot be broken unless you sell your home.  This is one of the main reasons you should consider working with a mortgage broker so they can help you navigate all of these potential pitfalls.

Some lenders do allow you to “port” your mortgage to a new home, but if they do not you may have to pay an interest rate differential penalty. These penalties are not small either. Homeowners have paid upwards of $10,000 or more to break their mortgage contract. Interest rate differentials were concocted to compensate the lender for the difference between the rate on your mortgage contract and the interest rate the bank could charge if they were re-lending the money. Unfortunately, the rate they claim they could get if they were to re-lend is much higher than anticipated.

Do Your Homework Before Signing Anything

Checking out what the penalties are on your mortgage before you sign on the dotted line is more necessary than ever. According to the Canadian Association of Accredited Mortgage Professionals, almost ten percent of Canadians refinance their home before the term is up. Besides that, more and more Canadians are looking to pay their mortgages off quicker. This can only be done if there are provisions for it in the mortgage contract. Some mortgages allow for lump sum payments on the mortgage any time. Others only allow it at the end of the mortgage term.

Penalties Vary From Lender to Lender

Most mortgages do include some type of penalty clause, but they certainly do vary. It is important that you know how the lender calculates them. Penalties can range from hundreds to tens of thousands of dollars. This is why focusing on the interest rate alone is insufficient. Often times “open” mortgages have a higher interest rate. They also give you the freedom to pay it off the mortgage at any time, penalty-free.

Not all penalties are as high as interest rate differential fees. A standard penalty on most mortgages is three months interest. Regardless, this is a substantial amount of money and lenders aren’t concerned with your reasons for breaking the contract either. They just want compensation. For those in the military, this means paying the penalty out-of-pocket as the government cut coverage for Armed Forces members in 2012. The Armed Forces now encourages military members to select portable mortgages for this very reason.

Get Some Help

There are so many variables included in a mortgage that it is important you have someone on your side to help you. A certified mortgage professional will work with you at no charge. They will help you find a product that is suitable now and in the future. Don’t be swayed by interest rates alone. Good terms are just as important to your needs.  Call mortgages.ca today at 877-245-1185 to learn even more about how Mortgage penalties work.

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