The Truth About Mortgage Prepayment Penalty Fees!
Prepayment penalties are fees charged if you pay off the principal balance of your mortgage prior to the mortgage term’s maturity date. Borrowers payoff their mortgage prior to the term’s maturity for a number of reasons – they switch lenders to take advantage of a lower mortgage rate, they refinance their home in order to take out equity, they consolidate all of their existing debts, or they have sold their home.
At the time of payoff, the penalty fee for a fixed-rate mortgage is typically calculated based on the original discount received off the bank’s posted rate, the prevailing mortgage rates at the time of payoff, the outstanding principal balance, and the remaining time to maturity (for a detailed explanation on how banks calculate their prepayment penalties, refer to “The Bank Is Giving Me A Big Discount Off Their Posted Rate. I Must Be Getting A Great Rate!?” in our FAQs. Note, all lenders utilize a different method to calculate their prepayment penalties and that is the subject of this article. For the same mortgage, we’ve seen the potential prepayment penalty at a major bank amount to $13,973, whereas, the non-bank lender’s prepayment penalty for the same mortgage was $2,258 - over five times the savings of the bank!
Based on this, you’d think that non-bank lenders would be the first choice for all borrowers. However, that isn’t the case. Most Canadians either go to the bank where they already have an existing relationship or to another major bank that has advertised a “special” low rate. Similarly, the prevailing belief that apart from the interest rate, mortgages are largely the same across lenders drives borrowers to consider only the major banks. Picking a mortgage lender due to a lower mortgage rate or the convenience of having one’s banking products at one institution is practical. However, when choosing a mortgage, borrowers should also consider non-bank lenders as the prepayment penalties can be several times lower than at a major bank with all of the other mortgage features being largely equivalent including the interest rate.
Failing to consider the prepayment penalties can potentially limit one’s future flexibility and end up costing tens of thousands of dollars extra. To show you what we mean, we have illustrated it in a concrete, real-life example below.
We recently had a married couple who were keenly determined to get their mortgage with a major bank. Based on their income and credit history, we were able to get them qualified at a major bank for a $630,000 mortgage (their own bank had qualified them for only $597,000). Based on the couple’s present situation and future plans, we thought it prudent to make them aware of the difference in prepayment penalty fees between the bank and non-bank lenders. We informed them that the non-bank lender we were suggesting is a specialist, institutional mortgage lender in the Canadian mortgage industry and also administers mortgages for major banks. Finally, we provided an analysis of the main differentiator between the banks’ mortgages and the non-banks’ mortgages - the prepayment penalty charges.
The following table shows the actual prepayment penalties between the two lenders for our clients’ mortgage using the same five-year fixed interest rate, the same initial mortgage amount of $630,000, and an assumption that rates stay the exact same over the next five years (downward rate changes will cause the penalties between the lenders to widen even further). These amounts were obtained using each lender’s own online prepayment penalty calculator.
|Month*||Balance||Bank Penalty||Non-bank Penalty||Probability|
|*Represents the number of months into the mortgage|
As seen in the table, there is a significant difference in the prepayment penalties between the two lenders. If we take this one step further and calculate the Expected Value (EV) of the penalty amount over the full mortgage term, using the probabilities in the last column, we get an Expected Value at the bank of $13,973 versus an Expected Value at the non-bank of $2,258. The probabilities shown are conservative estimates as actual data reports over two-thirds of mortgages in Canada are broken by the end of the fourth year. Apart from the prepayment penalties, essentially all of the other mortgage terms are basically equivalent between the two lenders’ mortgages (including our compensation).
This is an example of the type and depth of analysis we conduct for all of our clients as we guide them to their “Sleep Easy Mortgage.” Furthermore, this analysis isn’t meant to disparage the banks’ mortgage products as we do send a significant number of our deals to the major banks because it makes sense in those situations. Instead, the analysis is intended to encourage borrowers to consider mortgage features beyond just the interest rate and the lender. We will never suggest a mortgage product to our clients that we wouldn’t take ourselves if we were in their position. Also, the final choice will always be made by our client, based on their comfort level – our duty is to make that choice an informed one.
Sleep Easy Financial has access to 90+ mortgage lenders including the big banks. We beat the banks’ mortgages and our services are at no cost to you as we get paid by the lenders. Whether it’s for your next home purchase, mortgage renewal or refinance, our licensed mortgage professionals are committed to getting you your lowest rate so you save as much money as possible. We help you at every stage of the process and are with you for the life of your mortgage. Be mortgage savvy and let us shop your next mortgage for you. Contact us or schedule your complimentary consultation today.
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