How Are Prepayment Penalties Calculated?
How Are Prepayment Penalties Calculated?
Prepayment Penalties are meant to indemnify the lender for a borrower ending the term before the maturity date.
A prepayment penalty are typically either:
a) 3 month interest, or
b) The greater of:
- 3 months interest and
- the Interest Rate Differential (IRD).
There are other types of prepayment penalties, such as a certain percentage of the amount being prepaid, but 3 months interest and IRD are the most common. See your loan agreement to determine the penalty provisions of your mortgage.
Example
Prepayment Amount: $500,000 (A)
Interest Rate: 4.00% (or 0.04 as a decimal) (B)
Remaining Term: 2 years and 2 months (or 26 months) (C)
Current Rate for Remaining Term: 3.00% (or 0.03 as a decimal) (D)
How to Estimate the Three Months’ Interest
Step 1: _$500,000__ (A)
How much do you want to prepay that is not allowed under your prepayment privileges?
Step 2: __4% (or .04) _ (B)
Your current annual interest rate
Step 3: ___$20,000__ (E)
A x B = E (this an estimate of the interest for 1 years)
Step 4: __$5,000__ (F)
E ÷ 4 = F (this is an estimated three months' interest)
How to Estimate the Interest Rate Differential
Step 1: __4% (or .04) (B)
Your current annual interest rate
Step 2: _3% (or 0.03) (D)
The published interest rate for a fixed interest rate mortgage closest to the remaining term of your mortgage.
Step 3: __1% (or 0.01) (G)
B - E = F, the difference between your current rate and the rate in B
Step 4: _$500,000____ (A)
How much do you want to prepay?
Step 5: ___26 months ___ (C)
The number of months remaining on your current term
Step 6: ___$10,833.33__ (F)
Prepayment Amount (A) = $500,000
x Interest Rate Differential (G) x 0.01
x Number of months (C) x 26
÷ 12 / 12
F = the estimated IRD
Additional Fees
When you make a prepayment, you may have other fees charged in addition to the prepayment penalty.
A Mortgage Discharge Fee will be applied for preparing the discharge statement.
A Mortgage Assignment Fee will be applied if you choose to assign your mortgage to another financial institution.
Always consult your mortgage disclosure and/or your mortgage professional when deciding what product is right for you. The IRD calculation may not apply to your mortgage. CReview your mortgage disclosure/ documentation to understand the terms and conditions that relate to your mortgage.