Mortgage refinancing carries stiff penalties
By Gordon Powers, Sympatico / MSN Finance
Interest rates are down sharply – maybe even as low as they’re going to get – which means your existing mortgage rate is likely higher than prevailing rates. Is this then a good time to renegotiate?
With a five-year fixed rate now lower than 4% in some spots, the savings can be significant – particularly if you’re still far away from paying things off. But while the improved interest rate you might get is tempting, it's important to calculate how much you'd pay in penalties and how long it will take to recoup the cost of refinancing.
First off, you’re going to take a big hit, known as the interest rate differential or IRD, to break your contract. Once upon a time, that simply meant giving up three months interest – in other words, a penalty of a little less than your next three regular mortgage payments.
In this market, however, skittish lenders are holding out for a stiffer penalty based on a formula that includes the size of the mortgage, the number of months you have left to run, and the difference between the current and existing rates – as well as a few company-specific charges since no two lenders calculate the IRD exactly the same way.
For instance, assuming the following:
- Mortgage balance: $100,000
- Rate on existing mortgage: 5.35%
- Term left to maturity: 24 months
- Available rate: 3.95%
The two possible results are either three months interest, approximately $1,340, or an IRD charge of closer to $2,800. Guess which one the bank will favour?
You do have some options, however. Depending on your mortgage terms, lenders will often let you pay down 10 or 15% of the original amount you borrowed first. By doing this, you’ll reduce the penalty proportionately but there’s no way to completely avoid it.
Have a mortgage broker run the numbers for you to see where you stand.