# Calculating mortgage penalties



## MoneyGal (Apr 24, 2009)

My understanding of this issue is not great. 

An acquaintance is looking to sell her house and rent, instead of purchasing a new house. 

The mortgage on the house is not up. 

How will the penalty for breaking the mortgage be calculated?


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## Four Pillars (Apr 5, 2009)

I wrote this some time ago - not 100% sure about the accuracy..

_This is the greater of 3 months interest or the interest rate differential which is basically the interest differential payable on the two different rates. Ie if your current mortgage rate means you will pay $10k in interest over the next 2 years and you get a new rate which only involves $6k in interest then the breakage fee will include that $4k of interest which the mortgage company won’t be collecting. This breakage fee may seem like a lot if you have a several years left on your mortgage but it makes sense. Why would a company forgo $X of interest (and profit) by letting you lower your interest rate without charging a fee to cover it?_

Best thing to do is just ask the holder of the mortgage - they will tell you what the amount is.


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## MoneyGal (Apr 24, 2009)

Thanks, 4P. I also thought it was 3 months, but she said she thought it was 6 months. I actually have to figure this out at work in the next week or so as part of a project we are doing, but thought I'd get a jumpstart. 

As for just asking the mortgage lender: of course, this is the right and obvious thing to do. The situation is that the wife in the relationship wants to sell and rent, and the husband is not sure; the husband thinks the penalty is 6 months, and the wife doesn't know and ... probably would not phone the mortgage provider directly to find out. People are mysterious.


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## Racer (Feb 3, 2010)

Hi MoneyGal,

My understanding was that methods of calculating the IRD (or the 3 month penalty, but of course that's unlikely given how low current rates are) may vary according to the terms of the actual mortgage contract. It's faster & easier to call the lender and ask them to calculate it for you. Also, some lenders publish IRD calculators. Alternatively, you can request a copy of your friend's certificate of title at your local Land Titles Office for a few bucks, and then request the filed copy of the mortgage contract for another few bucks.

Here's a trick for your friend: since the amount of principal owing affects the IRD calculation, making the maximum allowable lump sum payment will reduce the penalty.


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## Dana (Nov 17, 2009)

I haven't done mortgages for years, but it use to be that if the mortgage was CMHC insured, the IRD didn't apply and the mortgage could be broken with 3 months interest penalty after 1 year. 

IRD was a complex calculation that I have never done without the aid of a computer program, but it use to look at the time left on the mortgage term - for example, 2 years and compare the rate on the mortgage with the current 2 year rate. The difference between the two rates represents what the lender is losing on the payout and that would be the IRD penalty amount. 

For example, if you have two years left on your mortgage and the lender can lend that money to another borrower for a higher rate for two years than they have lent it to you, you would pay 3 months interest penalty to get out of the contract. 

If you have two years left on your mortgage and the lender can lend that money to another borrower for two years for less than they have lent it to you, you would pay the IRD - the lender always makes sure they are not out of pocket. 

My knowledge may be obsolete, the calculations may have changed.


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## MoneyGal (Apr 24, 2009)

The couple in question is in serious financial trouble. They are selling in order to avoid bankruptcy and they will probably still make a consumer proposal. (So, no possibility of a large lump sum payment to reduce the IRD.)

(Aside: does anyone else here experience this? Probably. Because I "know about money," I tend to field a lot of these questions in my life.) 

I will tell her there's no way around it except to contact the bank directly and get the straight goods for them. They are both so passive though, I don't know whether they'll actually do this.


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## Dana (Nov 17, 2009)

Moneygal: If they have attractive mortgage terms and conditions vis a vis terms and conditions that are currently available, it is possible that they could sell the property to a purchaser willing to assume the remaining term of the mortgage. They may have to give on the price a bit to do this but if it saves them more than the IRD it may be worthwhile. 

Also, a phenomenon that I have noticed during the economic turmoil of the last couple of years is that there are investors in the market who will purchase properties from distressed vendors and rent it to them as long as the vendors sign a lease. Usually the purchaser pays the legal fees and assumes the mortgage. I have not been involved in one of these deals, so I do not know the ins and outs but I have met some investors who do these deals regularly.


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## cardhu (May 26, 2009)

MoneyGal said:


> contact the bank directly ...... They are both so passive though, I don't know whether they'll actually do this.


Well, then, one option would be to let them stew in their uncertainty. 

There is no way to know how much the penalty would be without either (1) reading the mortgage contract fine print, or (2) asking the lender … there is no industry standard for the IRD calculation AFAICT … more than likely, if your friend does ask the lender, they will NOT be provided with the detailed calc --- only the result of the calc. 



Dana said:


> it use to be that if the mortgage was CMHC insured, the IRD didn't apply and the mortgage could be broken with 3 months interest penalty after 1 year.


The rule was IRD could ONLY apply during the first 3 years of a term … that rule was apparently scrapped more than a decade ago … entirely lender’s discretion now.


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## Shayne (Apr 3, 2009)

cardhu said:


> Well, then, one option would be to let them stew in their uncertainty.
> 
> There is no way to know how much the penalty would be without either (1) reading the mortgage contract fine print, or (2) asking the lender … there is no industry standard for the IRD calculation AFAICT … more than likely, if your friend does ask the lender, they will NOT be provided with the detailed calc --- only the result of the calc.
> 
> The rule was IRD could ONLY apply during the first 3 years of a term … that rule was apparently scrapped more than a decade ago … entirely lender’s discretion now.


For a 5 year term you will pay the greater of 3 months interest or IRD if you break your mortgage.

If you were in a term longer than 5 years you are only required to pay 3 months interest if you are already 5 years into your mortgage.

IRD caculations are a PITA and calculated electronically the the lenders systems. Very few people will be able to show you exactly how they are calculated.


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## Future Money-Bags (Feb 23, 2010)

I don't know the whole situation of this couple you are 'trying to help', but recommending bankruptcy is not something people should use as a goal to help their financial crisis. I know a couple people who did this, after trying to seek financial help from 'planners' or 'consultants' or anyone that could help them at their banks.

When all this failed, they decided the only smart thing to do was claim bankruptcy. I do not believe in giving up all you have worked for; versus working 10x harder to make it work.

Good luck to them getting back on their feet, sorry I have no input on the mortgage penalties.


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## cardhu (May 26, 2009)

Shayne said:


> For a 5 year term you will pay the greater of 3 months interest or IRD if you break your mortgage.... If you were in a term longer than 5 years you are only required to pay 3 months interest if you are already 5 years into your mortgage.


You're alternating between "are" and "were" ... are you talking about the present or the past? 

The rule I was referring to was that IRD could only apply during the first 3 years of a term … after 3 yrs, you were only required to pay 3 months interest ... that rule was apparently scrapped some time ago.


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## Shayne (Apr 3, 2009)

Sorry, if you ARE.


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## Jungle (Feb 17, 2010)

Dana said:


> I haven't done mortgages for years, but it use to be that if the mortgage was CMHC insured, the IRD didn't apply and the mortgage could be broken with 3 months interest penalty after 1 year.


They scrapped that in 1999. All CMHC mortgages will face full bank penalties after 1999.


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## sprocket1200 (Aug 21, 2009)

i guess people aren't so mysterious after all. there is always a reason they wouldn't do the logical thing and just call the bank.

it is clearly starting folks. hang onto your hats and have your cash ready...


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