• Mortgage Penalty: When Should You Pay It?

    February 19, 2020
  • Mortgage Penalty: When Should You Pay It?

    Most mortgages have a term – a length of the contract or commitment that the mortgagor has made with the lender. Generally, if you break said contract by paying it off earlier than agreed, you will be subject to a penalty.

    Why is there a penalty?

    There is a penalty because the lender has earmarked that money to make a certain amount of interest over the term of the mortgage. They’re counting on it. So when you pay it off early, they lose. Or do they?

    When does the bank win/lose?

    When you pay off a mortgage early, the lender will likely take that money and lend it to somebody else. If current rates are higher than the mortgage rate you signed up for, the bank wins. Why? Because they will make more money elsewhere than they were making with you! In this case, the penalty is usually less. The opposite is also true. Lower current rates means the bank will lose and you will usually be penalized more. This calculation is called an interest rate differential. The penalty is generally less, the less time you have left in the term.

    So when should you pay?

    Paying a penalty needs to make sense. If you have more to gain by breaking your term than by staying, then you should pay. For example, current rates may have dropped so much that it just doesn’t make sense to stay. The savings outweigh the penalty. Another example: let’s say you are consolidating debt. It’s going to cost you $1200 to break the mortgage. By refinancing and consolidating, you will be saving $600/mth is credit card debt. In this case it would make sense to pay the penalty because it would pay itself off in 2 months and the rest is gravy!

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