Any time you “break” a fixed rate mortgage contract, you will be charged a fee. This fee is either an IRD – Interest Rate Differential – OR three months’ interest, whichever is more. Both are most commonly known as penalties. An IRD might apply if you had a 5-year term, but sold your house 3 years in. Because it is prior to the natural end of the mortgage term, the lender requires a pound of flesh.
IRDs are not charged on open mortgages, HELOC products or variable rate mortgages. Although, variable rate products do have a penalty, it is a standard 3 month interest payment.
The calculations of an IRD aren’t consistent as each financial institution may have a slightly different method. However, this is the basic calculation:
Differential X balance X number of months remaining in the term = IRD
(Differential is the difference between the rate of your term and the current rate)
To see how your financial institution calculates IRD, you’ll need to check the fine print on your mortgage contract. They may base the differential on the posted rate, which can often be very different from your negotiated rate.
Sounds complicated? It is.
A fellow mortgage broker has a GREAT calculator and further information on his blog here. Our advice is the same – contact your lender to find out exactly what you’ll be expected to pay if you are considering breaking your contract.
If you are selling and are facing an IRD, you may want to see if you can “port” your mortgage, where you take it to your new home and keep the rate. There are also options to add to your existing mortgage and create a blended rate. If rates have dropped you may come out ahead if the savings will be significant enough to cover the penalty AND include a healthy amount of interest saved.
The key is to talk to your broker and check the numbers.
Before you sign your mortgage paperwork, ask your broker or other mortgage professional about IRDs. A lawyer I work with said IRDs are the most misunderstood part of the mortgage contract and it’s easy to understand why. When negotiating your mortgage, ask about all of the terms noted in your contract and if you want a second opinion, let me know.
Written by Marci Deane, to see more check out www.askmarci.ca