We have talked about refinancing, and debt consolidation before. The math is simple; replacing high interest consumer debt with relatively low(er) interest rate mortgage money will reduce your monthly payments and overall interest costs. But when it comes to replacing our mortgages, hefty payout penalties often outweigh interest savings, and suddenly the math becomes complicated. Things have suddenly changed in 2015, making refinancing again beneficial, but first let’s examine payout penalties.

Generally speaking, payout penalties on mortgages are calculated using a simple set of formulas.

For variable rate mortgages, the payout penalty charged by a mortgage lender is 3 month’s interest. 3 month’s interest is calculated fairly simply; your monthly mortgage payments are made up of a principle payment, as well as an interest payment. on the day that the mortgage is being paid out, the mortgage company will see what the interest portion of your regular monthly mortgage payment is adding up to, and multiply that number by 3.

Fixed rate mortgage payout penalty calculations are often calculated as the greater of 3 month’s interest, or what’s known as the Interest Rate Differential. In the case of a fixed rate mortgage, 3 month’s interest is calculated in the same way as explained for variable rate mortgages above. The Interest Rate Differential is a calculation that compares the rate you are currently paying with the rate being offered by that lender for a term closest to what remains on your existing mortgage term.

For example, let’s imagine a situation where you are paying off your mortgage 3 years into a 5 year mortgage term. In this case, the mortgage company will compare your existing 5 year fixed rate with it’s current 2 year fixed rate offering. If your rate is higher than what is being offered, you will simply pay 3 month’s interest, however, if the 2 year rate is lower, your penalty will generally be calculated as follows:

[(your mortgage rate – the current rate) x remaining balance on your mortgage x number of months remaining on your term] / 12 = Interest Rate Differential Penalty

The mortgage company will compare 3 month’s interest with the Interest Rate Differential Penalty, and charge you the higher of the two options.

In the past, the interest savings achieved over the remainder of one’s existing 5 year mortgage would not outweigh the penalty costs enough to justify making the switch, however, 2015’s interest rate market has changed that. Aggressive variable rate, and fixed rate mortgage interest rate pricing has resulted in a situation where selective rate specials are offsetting normal pricing and penalties. Even after paying an interest rate differential penalty, home owners are savings substantial money by refinancing.

Let us now examine how these savings are coming about with an example where a homeowner who currently owes $420,000 on his mortgage at 3.89%, replacing it with a new mortgage at 2.15%. To make the comparison fair, let’s only look at the savings that will be achieved over the remaining 3 years left on the homeowner’s existing mortgage at 3.89%.

	Existing 3.89% Mortgage	New 2.15% Mortgage	Difference over 36 months remaining on existing mortgage term
Monthly Payment	$2,064.98	$1,817.66	$8,903.52
Interest in Payment	$1,346.88	$752.72	$21,389.76
Balance in May 2018	$389,869.31	$354,622.37	$35,246.94
Total			$65,540.22

Penalty calculation:

Current 3 year rate offered by most lenders used for IRD calcuation: 2.35%

[(3.89% – 2.35%) x $420,000 x 36]/12 = $19,404

With savings over the same 3 year period coming in at over $65,000, even with a substantial $19,404 payout penalty the home owner would see a total cost savings of $46,136 in just 3 years!

2015 is providing a tremendous opportunity for homeowners to save money by taking advantage of lower than normal interest rates. To find out mortgage about how refinancing your mortgage could save you money, contact Alberta Mortgage at 780-479-2222 today.

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Anuj