Beware the IRD Mortgage Penalty

IRD, a home owner's most feared three letter acronym!

Clients looking to refinance their existing mortgage to lower their rate or moving to a new property, run into this term every time, especially these days.  The size of an IRD (interest rate differential) penalty depends upon who you have your mortgage with, not just the interest rate you have on your mortgage versus current rates.  The penalty clause when breaking a fixed rate mortgage is:  the greater of IRD or three months interest.  (Variable rate mortgages by nature do not / cannot have an IRD).  As plain and simple as possible - major retail banks have "posted rates", other non-retail lenders, accessed through independent mortgage brokers, do not have posted rates.  Retail bank lenders use the discount off of the posted rate that they originally gave you on your mortgage and apply it against the posted rate today for the remaining term of your mortgage to calculate an IRD penalty.  Retail banks have a data field in your mortgage file where they track the discount they gave you, i.e. they never forget it!  Non-retail lenders do not do this, they simply compare the discounted rate that they gave you to their current discounted rate for the term remaining on your mortgage.  They do not use a calculation using a "discount" originally given to you.  The difference is significant, here is an example of a couple who came to us for guidance recently:

Couple had a 5 year fixed rate of 3.69% - an acceptable rate a few years ago.  They had three years remaining on their term and were moving to the U.S. to take on a new career opportunity.  Their mortgage was with a large retail bank and they were expecting a three month interest penalty to exit the mortgage.  After querying the bank about their penalty they were told that the penalty would be $10,642.  At the time that they entered into their mortgage they could have gone into a non-retail mortgage lender at the same rate, and the penalty applicable to them under these same circumstances would have been $4,125. 

Mortgage amount remaining: $275,000:

 

 

Scenario Retail Bank Lender Non-Retail Lender
Existing rate 5 yr fixed; 3 years remaining. 3.69% 3.69%
Current posted rate remaining term (3 yr) 3.99% 3.19%
Discount received on original 5 yr fixed rate

term mortgage   

1.59% 0%
Net IRD rate, remaining term 2.40% 3.19%
IRD rate used for penalty calculation 1.29% 0.50%
IRD penalty on remaining mortgage balance for remaining term (3 yrs) $10,642   $4,125

Always, always use an independent mortgage broker for all of your financing needs!  Whether it be residential or commercial lending, or even loans and lines of credit.  A broker is your best bet because they are independent of lenders, and shop the market for you.

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