Prepayment penalty중도 상환 위약금

What is it?

A mortgage has a "term", usually one to five years, during which the rate and conditions are fixed. Most mortgages are closed mortgages: if you pay more than the contract allows before the term ends, the lender charges you for it. That charge is the prepayment penalty, also called a prepayment charge.

An open mortgage can be paid off at any time without a charge, but it usually carries a higher interest rate.

The penalty is not a fine. It compensates the lender for interest it expected to receive. So it grows when rates have fallen, when a lot of the term is left, and when the balance is large. The Financial Consumer Agency of Canada (FCAC) warns it can cost thousands of dollars.

When do you pay it?

According to FCAC, these events can trigger a penalty on a closed mortgage.

• Selling your home and paying off the mortgage mid-term. Your lawyer pays out the mortgage on closing, and the penalty comes out at the same time.
• Refinancing, that is, replacing the mortgage to borrow against your equity (the home’s value minus what you owe).
• Breaking and renegotiating the contract because rates have dropped.
• Moving the mortgage to another lender before the term ends.
• Paying more than your prepayment privileges allow. Payments within the privileges carry no penalty.

There is no penalty if you pay off or move the mortgage on the maturity date (the day the term ends). A variable-rate mortgage that is closed still has a penalty.

How is it calculated?

FCAC describes the two most common methods. Your mortgage contract says which one applies, or whether the lender takes the higher of the two.

The IRD is only large when today’s rate is lower than your contract rate. If rates have gone up, the gap is zero or negative and three months’ interest usually applies. An administration fee may be added on top.

Worked example

This is FCAC’s example. Balance $200,000, contract rate 6%, 36 months left of a five-year term, and the lender’s current rate for a three-year term is 4%. Estimates for reference only; the real calculation is set by your contract and lender.

If the same person broke the mortgage with 12 months left and the rate gap were still 2%, the same formula gives an IRD of $200,000 × 2% ÷ 12 × 12 = $4,000 (our own illustration, not FCAC’s). The more time left and the bigger the rate gap, the larger the IRD.

If you got a discounted rate, the IRD changes

Lenders usually advertise a "posted rate" without any discount, and you may be able to negotiate a lower rate before you sign. If you got a discount, the IRD calculation depends on the lender and your contract. FCAC describes these three methods.

• Lenders that compare the posted rate when you signed with today’s posted rate for the term remaining.
• Lenders that use your discounted rate and also apply the discount to today’s rate: FCAC says the rate gap stays the same as with posted rates, so the result is very similar.
• Lenders that use your discounted rate but compare it with today’s posted rate without a discount: FCAC says this usually results in a lower penalty.

Which rates are compared can change the penalty. Do not look at the rate alone; check the IRD method in the contract before you sign.

After five years: a cap set by law

Section 10 of the federal Interest Act applies to a mortgage that is "not payable until a time more than five years after the date of the mortgage", in other words a term longer than five years. Once five years have passed, the borrower can pay the balance plus interest to the date of payment plus three months’ interest, and no more interest can be charged. So on a seven- or ten-year term, the penalty after year five is capped at three months’ interest.

This protection is for individuals only. It does not apply to a mortgage given by a corporation. Ontario’s Mortgages Act, section 18, says the same thing.

It does not help with a term of five years or less. If you take a five-year fixed and break it in year three, your contract’s formula (such as the IRD) applies.

How to reduce the penalty

• Use your prepayment privileges first: many contracts let you prepay a share of the original amount each year without penalty (FCAC’s examples use 10 to 15%). Prepay that much before breaking, and the penalty is calculated on the smaller balance. Some lenders block prepayments within 30 days of the payout date.
• Wait for maturity: if the penalty is large, time the sale or switch for the end of the term. Unused privileges usually do not carry over to the next year.
• Port the mortgage: if you sell and buy, the lender may let you take your rate and conditions to the new home. If you need more money, the extra may be blended at the new rate, so check the terms.
• Blend-and-extend: some lenders let you extend before the term ends by blending your old rate with the new term’s rate. FCAC notes this may still trigger a prepayment charge (blended into the new rate or paid at the time) and an administrative fee.
• Stay with the same lender: if you break and take a new mortgage with the same lender, ask whether it will reduce the penalty. Some lenders add the penalty to the new mortgage, but then you pay interest on it.
• Choose well at the start: if you may sell within two or three years, a shorter term, an open mortgage, or a lender with a fairer IRD method can matter more than 0.1% on the rate.

Before you sell or refinance

1. Call your lender, ask for today’s penalty, and request a written statement. The amount changes daily with rates and your balance, so check again close to your closing date.
2. Read the "information box" at the front of your mortgage agreement for the privileges and the penalty formula. Federally regulated lenders such as banks must include it by law.
3. If you are selling, subtract the penalty from the sale proceeds to see what you keep. If you are refinancing, compare the interest you save at the new rate with the penalty plus costs (lawyer, appraisal, registration).
4. Ask the same lender about porting, blend-and-extend or a reduced penalty, and get other lenders’ offers through a mortgage broker. In Ontario, mortgage brokers and agents must be licensed by FSRA.
5. Once decided, tell your lawyer. On closing, the lawyer pays the balance and penalty according to the lender’s payout statement and discharges the mortgage.