Paying the Penalty

The interest rate has just dropped and you wonder if you should try and get a lower rate on your mortgage, but there are penalties involved in breaking your mortgage agreement. Hammy...what to do?

Once we are indebted to a mortgage broker or a bank, that financial institution prefers us to stay the course. They have already calculated that they will be receiving X amount of dollars from you for the next five years (or three years etc) and these figures are in their investment portfolio. Your money has been ear-marked by them as their known quantity of 'spending money', usually to be invested in the stock market.

The finance companies like things neat and tidy. They discourage you to mess about with their plans. And they certainly do not like to lose money, hence the penalty for changing your mortgage (you will only change it if the rate goes down).

However, they are willing to talk to you about a change in your mortgage, so it is worth making an appointment to see what their calculations and advice amount to.

The two main factors to take into account are: how much the drop in interest rates amounts to and how much is the penalty. Each contract may have a different penalty. Some companies use a set amount, say $3,000 and some companies charge you three months extra payments, and there are many variations in between.

The Internet has many mortgage tables to help you to calculate your exact repayment differences. Just one quarter per cent is a minimal difference, but one per cent is a big difference, as this example shows:

In this example the amortization is 240 months (this is 20 years, the complete length of time of the loan - regardless of the smaller mortgage periods) and the interest rate is 7.5%. Let us imagine that hypothetically, the interest rate has been gradually dropping and it is now at 6%.

Your monthly repayment is $1,550 and you have two more years ( 24 months) left to pay at this rate.Even if you have the three month penalty clause to pay and you add it onto your total mortgage, your monthly payments, albeit with this slightly larger mortgage amount (the penalty of $3,000) will be lower. They will be $1291 and your savings over the last two years of your repayment period will be $5,016.

Many times the interest rate is not so marked as the example, but contra to what most people think, it is worth looking your figures up on a mortgage table, or phoning your bank to check.