Do you know how your penalty is calculated?
There was a client who was quoted a penalty of about $6,370 to break her $280,000 mortgage a month ago, yet today, her penalty has ballooned to over $12,000.
How did this happen in the span of a month?
On both penalty quotes, the client is being charged the interest rate differential: the interest lost to the lender for the remainder of the term.
The IRD is based on several factors: the difference between your rate and the rate at which the lender could re-lend the money (the spread), the amount being prepaid, and the time remaining.
Here's how it's calculated:
IRD = spread x balance x # of months left to end of term/12
When she first called the bank to get a penalty quote, she had 42 months left which is closest to a 4 year term. At the time, the bank's posted 4 year rate was 4.64% & the penalty was calculated as follows:
Client's rate: 3.64%
4 year rate: 4.64%
Client negotiated a GREAT discount of 1.65% when she got the mortgage 18 months ago ( now she's going to pay for it).
You'd think the spread would be the difference between would be the difference between 3.64% and 4.64% (now the bank can EARN an extra 1% by getting the money back early), but, THIS bank takes into account the discount of 1.65% negotiated by the client. They would theoretically lend the funds out based on a rate of only 2.99% "passing along" the 1.65% discount.
spread = 3.64% - 2.99% = 0.65%.
IRD = 0.65% x $280,000 x 42/12 = $6,370
Easy math, but how does that become over $12,000 a month later.
The spread is based on the rate closest to the remaining term. With only 41 months remaining, the bank now looks at their 3 year rate which is 3.95%.
Client's rate: 3.64%
3 year rate: 3.95%
Don't forget the discount of 1.65%
spread = 3.64% less (3.95%-1.65%) = 1.34%
IRD = 1.34% x $280,000 x 41/12 = $12,819
The additional month that has passed has resulted in a penalty that is almost $6,500 higher than quoted a month ago.
How the IRD is calculated varies between one lender and another.
As a mortgage agent I can help you understand these risks and steer you to lenders who are less "calculating" in how they punish their clients.
