What are prepayment penalties?
Prepayment penalty is a penalty which can be levied by your mortgage lender in case you pay a sum which surpasses the sum allowed as the additional money towards your mortgage. A pre-penalty can also be levied in case you break your mortgage contract or transfer the mortgage to another lender before the end of your term with the current lender. You may also have to pay a pre-penalty if you get a windfall or for some other reason you decide to pay up your mortgage sum in its entirety before the mortgage term ends. This includes the time when you sell your home. A prepayment penalty is sometimes also known as a breakage cost or prepayment charge.
Since prepayment penalties can be quite costly you must know the conditions under which they can be levied and also how they are calculated. However, you should know that in case you have an open mortgage you are allowed to make a pre-payment without being charged a penalty on the same.
Pre-penalty payment terms differ from lender to lender. Lenders mostly lean towards limiting the amount which can be pre-paid per year. They usually do not allow the pre-payment amount to carry forward to the next year. For example, if you are allowed to prepay 10,000 CND a year and you pre-paid only 8,000 CND in 2020, you cannot pay 12,000 CND in 2021. You would be allowed to pre-pay only 10,000 CND in 2021. Before signing your contract you must find out:
If you are allowed to make prepayments by your lender
In what circumstances does the lender allow you to make prepayments
If there is a cap to the minimum or maximum amount which can be pre-paid
What are the prepayment fee or penalty which you would have to pay
Other conditions in the contract related to prep-payment penalties.
How are prepayment penalties calculated?
Calculation of prepayment penalty may vary from one lender to another. Most regulated lenders such as banks have a calculator on their site which allows you to calculate your estimated prepayment penalty which may depend on the following factors:
How much do you want to prepay
How many months away are you from the end of your term
Interest rates
How is the fee calculated by your lender
How to avoid prepayment penalties
In order to avoid prepayment penalties you should use your prepayment privileges to their maximum capacity every year. By doing so if a situation arises when you have to pay prepayment penalties they will be calculated on the basis of a lower mortgage balance.
Prepay at the end of your term if the penalty is a huge amount. A lump sum prepayment without penalty can thus be made.
Consider a mortgage port which means taking your existing interest rate, terms, conditions to your new home. Doing so ensures you do not break your current mortgage contract to get a new one.
If you have any questions or doubts relating to pre-payment penalties do reach out to us. We would be happy to help.