Mortgage Penalty Calculator
The mortgage penalty calculator helps you estimate the prepayment penalty or charge that would apply if you prepaid your mortgage loan. Prepayment means paying off your mortgage faster than the initially agreed schedule. If you're here, you've probably checked out the mortgage prepayment calculator, which deals comprehensively with how you can save money and pay off your mortgage in time without incurring any mortgage fees. But if you haven't, make sure you check it out now!
You can read further here to learn about how the prepayment penalty or charge is calculated on your prepaid mortgage. Usually, the estimated charge is whichever amount is greater between two calculations – the three months' interest on the amount you are prepaying or the interest rate differential (IRD) on the amount you are prepaying. With the mortgage penalty calculator, you don't need to bother making these calculations manually. Input the details from your most recent mortgage loan documents into this mortgage penalty calculator, and you'll get your result.
What is mortgage prepayment penalty (or prepayment charge)?
A mortgage prepayment penalty is an agreement between a borrower and a bank or mortgage lender regulating what the borrower can pay off and when.
When you prepay your mortgage, you make extra payments to the regular periodic (monthly, semi-monthly, biweekly, etc.) installments you are expected to pay. Mortgage lenders have a love-hate relationship with these prepayments. On the one hand, they're glad a borrower did not default on the loan payment, but on the other hand, they have to forgo the interest they would have gained if the borrower had stuck to the original loan agreement.
Furthermore, lenders insure mortgage loans by offering them as bonds to investors who are paid with some interest on the loan. So if a loan is prepaid and the interest is less, they rarely profit. That is why most lenders often include a mortgage prepayment charge or penalty clause in the mortgage loan contract to compensate for the economic costs.
After paying a registration fee and discharge fees to cover the paperwork of a mortgage process, the last thing you want is another fee to penalize you for paying off your mortgage sooner. But mortgage lenders, especially in Canada, try to balance the effect of loan prepayments on their bottom line by offering different types of mortgage loans to make the mortgage contract attractive. The mortgage prepayment penalty calculator will help you decipher how much you may be charged.
Types of Mortgage loans – loan prepayments
Some different types of mortgage lenders offer with a prepayment penalty are:
Open end mortgage – with a high-interest rate but no restrictions or prepayment penalty on how much or when you can pay off the loan;
Closed mortgage – with a low-interest rate and prepayment penalty;
Variable-rate closed mortgage has fluctuating interest rates depending on market changes but a fixed mortgage prepayment charge; and
Fixed-rate closed mortgage has a fixed interest rate throughout the loan term, but the estimated penalty is charged based on how long you've held the mortgage loan. For example, the prepayment penalty may be higher if you pay off your loan in 1 year than if you pay it off in 2 years.
Some mortgage loans come with prepayment privileges that allow borrowers to pay off up a certain percentage of their outstanding loan balance each year. It is always a good idea to consider this when comparing mortgage deals. You may be offered the privilege to pay off up to 20% of a loan balance each year. Or increase your monthly mortgage payments by up to 20% once each year. The privileges vary between lenders, but it ensures that if you ever decide to prepay your mortgage loan, you are only charged a mortgage penalty on the amount exceeding the prepayment privilege.
Types of mortgage prepayment penalty
There are two types of loan prepayment penalties according to the terms of a mortgage contract. Knowing which type your mortgage lender insists on could be crucial when choosing a provider.
The two types are the:
Soft prepayment penalty – allows the sale of the home without penalty. But you pay the penalty if you refinance the mortgage. Selling the home to another buyer means that you pay off the mortgage loan in full, often with interest, because the sale price is above the original home purchase price.
Hard prepayment penalty – do not allow any exceptions without penalty. So, whether you sell the home or refinance your mortgage, you will be penalized. Although the hard prepayment term is quite harsh, other conditions on the mortgage contract may be worth considering the deal.
Generally, the mortgage loan prepayment penalty is designed for the following reasons:
- To make the loan interest rate cheap and attractive;
- Discourage borrowers from refinancing their mortgage, selling the home during the mortgage term, or paying off the loan too early;
- Stop the transfer of a mortgage to another lender, and
- Provide compensation for mortgage bond investors.
Different lenders offer different loan prepayment terms, so you must ask that the terms are explained adequately before closing a mortgage contract, else you might incur an unplanned mortgage penalty when you want to prepay.
In the US, the Consumer Financial Protection Bureau (CFPB) created under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, established rules to govern prepayment penalties, as follows:
Determine what types of mortgage loans can charge prepayments:
Restrict mortgage prepayment penalty to the first three years of the loan term.
Restrict the maximum amount lenders can charge as a prepayment penalty in the first two years of the loan term to 2% of the outstanding loan balance. And 1% of the outstanding balance in the third year.
Insist that if a mortgage lender offers a loan with a prepayment penalty, it must also offer an alternative loan package with no prepayment penalty.
Mortgage lenders must provide full disclosure on the prepayment penalties to borrowers – no hidden charges.
Ultimately, the prepayment penalty protects the lenders and investors who purchase the loan if a borrower pays off too early, and they lose interest gains. Simultaneously, the mortgage insurance premiums borrowers pay along with the monthly installments also protect lenders if the mortgage loan payments default. Thus, the CFPB set up the prepayment rules to protect US homeowners from predatory prepayment penalties.
How to calculate mortgage prepayment penalty
Full or Partial Prepayment
The calculation of the prepayment estimate differs if you are prepaying only a part of your outstanding mortgage balance (Partial prepayment) or the whole outstanding balance (Full prepayment).
You may need to consult with your mortgage provider to ascertain how they determine the prepayment penalty. Still, the mortgage penalty calculator will give you an idea of what to expect, so you can decide what is acceptable. If your mortgage is a:
- Variable-rate closed mortgage – you will pay three months interest on the amount you are prepaying based on the rate on the day of prepayment,
But if it is a:
- Fixed-rate closed mortgage – you will pay the higher of three months interest on the amount you are prepaying or the interest rate differential (IRD) on the amount you are prepaying.
Interest rate differential (IRD) is the difference between your current mortgage rate (plus any rate discount you may have received) and the current or posted interest rate charged for a new mortgage with a similar term at the time of the prepayment.
The Formula calculates the IRD for 1-year:
((current mortgage rate – posted interest rate) / 100)
Formula to calculate the three months' interest
current mortgage balance * ((current mortgage rate /100) / 4)
((total number of prepayments made since January 1st of current year + proposed prepayment) - (original mortgage principal balance * maximum allowed %)) * ((current mortgage rate /100) / 4)
Formula to calculate IRD amount
current mortgage balance * ((current interest rate - posted interest rate) / 100 / 12) * Number of months remaining in current term
((total number of prepayments since January 1st of current year + proposed prepayment) - (original mortgage principal balance * maximum allowed %)) * ((current interest rate - posted interest rate) / 100 / 12) * Number of months remaining in current term
((current interest rate - posted interest rate) / 100 / 12)is the IRD for a month; and
maximum allowed %is the percentage of your mortgage loan you are allowed to prepay annually as your prepayment privilege.
Example 1: Estimating prepayment charge for a variable rate closed mortgage
Danielle has a variable rate closed mortgage. She wants to pay off all the full outstanding balance of $50,000 on the mortgage.
The prepayment charge would be equal to 3 months' interest on the amount she is prepaying, which is calculated based on the interest rate posted on the prepayment day. The posted interest rate is 4.5%.
The prepayment charge to pay off the mortgage is calculated as:
= current mortgage balance * ((current mortgage rate /100) / 4)
= $50,000 * ((4.5/100) / 4)
Danielle will pay an estimated additional amount of
$562.50 as the prepayment charge along with the $50,000 prepay.
Example 2: Estimating the prepayment charge of partial prepay for a fixed-rate closed mortgage
Supposing Danielle took a mortgage loan of $250,000 at a fixed interest rate of 4.5% for 10 years. She had received a rate discount of 0.5% when she started the mortgage loan 7 years ago. The lender also offered her the privilege to pay off up to 10% of the outstanding loan balance each year.
Today, Danielle wants to prepay
$30,000 after receiving a substantial end-of-year bonus at work. Earlier in the year, she had prepaid
$10,000. Today, the posted interest rate is 3%, and her current mortgage balance is
$95,000. We can calculate the penalty on the payment exceeding her prepayment privilege as the higher of either of the two amounts:
- 3 months of interest at her interest rate of 4.5% plus the discount rate she received of 0.5%, which equals
- the IRD amount.
Step 1 – collect the data:
Original mortgage loan =
Outstanding mortgage balance =
The total amount of prepayment since January this year =
Proposed prepayment =
Prepayment privilege (maximum allowed %) =
Number of months remaining in the current term =
3 years * 12 =
Current mortgage rate =
Posted interest rate =
Step 2 – determine the estimates:
- Estimate of 3 months of interest using the formula for partial prepayment:
= ((total number of prepayments made since January 1st + proposed prepayment) - (original mortgage principal balance * maximum allowed %)) * ((current mortgage rate /100) / 4)
= (($10,000 + $30,000) - ($250,000 * 0.1)) * ((5/100) / 4)
= ($40,000 – $25,000) * (0.0125)
= $15,000 * 0.0125
An estimate of the three months' interest is
- Estimate of the Interest Rate Differential Amount (IRD)
= ((total number of prepayments since January 1st + proposed prepayment) - (original mortgage principal balance * maximum allowed %)) * ((current mortgage rate - posted interest rate) / 100 / 12) * Number of months remaining in current term
= (($10,000 + $30,000) - ($250,000 * 0.1)) * ((5 – 3) / 100 / 12) * 36
= ($40,000 – $25,000) * (2 / 100 / 12) * 36
= $15,000 * 0.001667 * 36
So, an estimate of the IRD amount is
Therefore, Danielle's estimated prepayment charge is the IRD amount, which is the higher of the two amounts -
Example 3: Estimating the prepayment charge of full prepayment for a fixed-rate closed mortgage
Outstanding mortgage balance =
Current mortgage rate =
Number of months remaining in current term =
Posted interest rate =
- 3 months Interest:
= $ 350,000 * ((5.50/100) / 4)
- Interest rate differential amount:
= $150,000 * ((5.50 – 4.40) / 100 / 12) * 26
Hence, the mortgage lender will subject the borrower to paying the IRD amount because it is greater.
How to avoid or reduce mortgage loan prepayment penalty, discharge fees, and registration fees
The simplest way to avoid the prepayment penalty is to find a mortgage lender who doesn't charge a penalty. In doing that you will cut out many fees that are usually attached to the prepayment penalty. Some lenders offer ways to avoid prepayment charges. However, when shopping for mortgage deals, some ways to place yourself in a good position in case you decide to prepay in the future are:
If you must take a loan with a prepayment penalty, find out:
If it's a soft or hard prepay – favor a soft prepayment penalty;
How long the prepayment lasts – favor prepayment penalties or fees that expire after a certain period of the loan term is covered over those that last the entire term of the loan;
If there are prepayment privileges – exhaust your prepayment privileges with no penalties before taking on extra payments to avoid any hidden mortgage fees; and
The maximum percentage of the loan the penalty amounts to – usually, a charge of 1-2% of the loan amount is considerable. The mortgage penalty calculator is a great tool to help determine this.
Make your mortgage payments more frequent. Switching to an accelerated weekly or biweekly payment schedule pays down the mortgage principal faster with no penalties.
If your lender allows, port your current mortgage term, interest rate, and outstanding principal balance to a new property when selling and buying a new home.
Transfer the existing terms and conditions on your current mortgage to the purchaser when selling your home.
Consider an open mortgage if the interest rate makes financial sense.
- It is important to note that additional mortgage fees may apply if you make a full prepayment to close or discharge your mortgage, such as discharge fee, registration fees, an assignment fee, etc.
- The methods for calculating the prepayment penalty may vary among lenders.
- The mortgage penalty calculator only provides an estimation of your prepayment penalty based on the data you provided. The exact prepayment penalty may differ from the estimate. Therefore, please contact your mortgage provider to determine the exact prepayment charge on your mortgage.