Avoiding Surprises: A Clear Guide to Mortgage Penalties

Many homeowners often find themselves with a mortgage but don't fully understand mortgage penalties. And I get it! Buying a home and getting a mortgage can be overwhelming, to say the least! But if you're considering purchasing a home, refinancing, selling, making a lump sum payment, or need a way out, I encourage you to read on.

The most common mortgage penalty my clients encounter is a prepayment penalty. Did you know? Your lender doesn’t want their money back early! That’s because they earn guaranteed interest on the loan, helping them not only budget but also make a profit. Let’s go over the types of prepayment penalties:

Prepayment or Overpayment: If you make a lump sum payment on your mortgage or increase your regular mortgage payments by too much, you could be outside the terms of your mortgage agreement and face a prepayment or overpayment penalty.

Transferring: If you move your mortgage to another lender before the end of your term, that is considered breaking the mortgage agreement you made and will leave you with a prepayment penalty.

Early Repayment: If you sell your home and use the sale proceeds to pay off your mortgage in full, this is considered breaking your mortgage agreement, which will result in a prepayment penalty charged by your existing mortgage lender.

Breaking your mortgage for these—or any other reason—almost always results in a prepayment penalty. The amount of the penalty that could be owed will be based on a few factors:

• The amount of pre- or over-payment you're making against your existing mortgage balance
• Interest rates (your existing interest rate and current market rates at the time you're breaking your mortgage)
• The type of mortgage you currently have (open or closed) and the type of interest rate (fixed or variable)

How can you reduce or avoid prepayment fees?

The simplest answer is to wait until the end of your existing mortgage term to make changes or alterations to your mortgage. If that’s not an option or possible, let’s review your circumstances:

• Do you have a fixed or variable interest rate? If you have a variable rate and you’re breaking the mortgage in favour of a fixed option, first check to see if you can lock in a rate under your existing terms with your existing mortgage lender.
• Are you making a lump-sum payment? Review the terms of your mortgage to see what your annual prepayment allowance is. Most mortgages will let you make some fixed lump sum payments without any penalties up to a certain percentage.

When can penalties be worthwhile?

It is important to note that sometimes, paying a penalty can be worthwhile—especially if you're currently locked into a higher-rate mortgage and the savings from breaking it and securing a lower rate outweigh the prepayment penalty costs you will incur. I can help you with this determination and if this makes financial sense for you.

An alternative to mortgage penalties

If the likelihood of your breaking your mortgage agreement early is high, consider opting for an open mortgage. An open mortgage is a great short-term solution for anyone who may have future plans that will cause them to break their mortgage term early, such as an inheritance coming up, a future move out of town, or perhaps a change to your relationship (i.e. marriage, divorce, separation, etc.). With this type of mortgage your regularly pay the mortgage as long as you need it, but when you sell your property there is no prepayment penalty to pay out the mortgage balance. However, this mortgage option does typically come with higher interest rates, but the benefit is that there are no penalties to pay it off at any time so you'll need to weigh the pros and cons!

Whatever type of mortgage penalty you might be have, my recommendation is to talk to me for expert advice. Do this before you make any commitments so we can go over the fine print and you can understand what you’re getting into! I always take the time to do this with my clients, and I would be happy to assist you also.