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Understanding How Mortgage Penalties Work

Understanding How Mortgage Penalties Work

person researching mortgage options

person researching mortgage options

It is important before signing any mortgage agreements to read the fine print. Mortgage penalties are an important part of a mortgage agreement; however, most homeowners don’t find out about them until they have to pay them. When shopping for a mortgage, you should carefully consider your options and choose a mortgage that best fits your long-term needs. This way, you will avoid or at least lessen your chances of running into any mortgage penalties.

In this article, I will review with you the different ways you can be charged for a mortgage penalty and why they are in place.

What is a prepayment penalty?

A prepayment penalty is a fee that your mortgage lender may charge if you do one of the following:

  1. Pay more than the allowed additional amount toward your mortgage
  2. Break your mortgage contract
  3. Transfer your mortgage to another lender before the end of your term
  4. Payback your entire mortgage before the end of your term, including when you sell your home

Your lender may also call the prepayment penalty a prepayment charge or breakage cost. In a nutshell, a mortgage penalty is when you violate the terms of your original mortgage agreement. These penalties can cost thousands of dollars, which is why it’s important to know which type of mortgage you need before you agree to anything. As an example, if you opt for an open mortgage, you can make a prepayment or lump-sum payment without paying a penalty.

How much does a prepayment penalty cost?

Most, if not all mortgage agreements have some type of clause about penalties, but they can vary. The cost of a prepayment penalty depends on a few different factors. It will depend on the type of mortgage penalty, the type of mortgage you have, and the lender you signed with. The way a mortgage penalty is calculated varies from lender to lender as well.

Not all penalties are tens of thousands of dollars. While there is no set number on how much a penalty would cost, a standard penalty on most mortgages is roughly three months’ interest.

Do your research before you sign anything

Before you jump into a mortgage with the lowest interest rate, it’s important to review what penalties are on your mortgage before you sign. It’s also important to see if you have any prepayment privileges. A prepayment privilege is an amount you can put toward your mortgage on top of your regular payments, without having to pay a prepayment penalty.

When reviewing your mortgage contract, check the terms to find out: 

  1. If your lender allows you to make prepayments
  2. When your lender allows you to make prepayments
  3. If there’s a minimum or a maximum amount that you’re allowed to prepay
  4. What fees or penalties apply
  5. If there are other conditions

If your contract allows you to make additional payments, typically there is a limit to how much you’re allowed to prepay each year.

More now than ever, Canadian homeowners are looking for ways to pay off their mortgages quicker. But if you don’t have the provisions for it in your mortgage contract, you could end up paying some pretty extravagant fines. Some mortgages allow you to make lump-sum payments, while others only allow it at the end of your mortgage term. Again, it all depends on who your lender is and the type of mortgage you decide to go with.

As an example, if in the future you want to have the flexibility to make lump-sum payments, an open mortgage may be better for you. While open mortgages have a higher interest rate, you will have the ability to pay off your mortgage faster, penalty-free.

Or let’s say you know you will not be staying in your new home for very long. You will want to make sure you are able to break your mortgage contract with the mortgage company. Most mortgage options are “locked-in” until the end of the entire term of the mortgage unless a penalty is paid to the lender. So in this case, you will want to opt for a mortgage where the terms are more flexible.

Why do these mortgage prepayment penalties exist?

Obviously, you don’t want to pay a penalty fee, but lenders have them in place for one very important reason: to protect themselves. Lenders want to be able to recoup some of the interest that will be lost if a homeowner decides to pay off the contract before the end of the mortgage term. Seems fair enough. However, these charges are often pretty substantial. Lenders include large prepayment penalties as a way to discourage homeowners from breaking their contracts or paying off their mortgage earlier.

If you are purchasing a new home and you want a new mortgage, some lenders may waive the penalty fees if your new mortgage is signed with them as an existing customer. Other mortgage contracts cannot be broken otherwise unless you sell your home. This is one of many important reasons why you should work with a mortgage broker. So, they can help you navigate and explore different instances that may come up along with the mortgage options available to you in each situation.

Ready to talk about mortgages? I’m here to help!

Mortgages can be complex, and it’s in your best interest to work with someone who knows the ins and outs of the mortgage world with an in-depth knowledge base. As a professional mortgage broker with over ten years of experience, I can help you choose the right mortgage that matches your financial needs today and long term. Remember, don’t be swayed by interest rates alone. Mortgage terms are just as important as what rate you lock that mortgage in for. When you’re ready to chat, submit your mortgage application to me by clicking here to get started or you can give me a call at 705-315-0516.

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