Breaking A Closed Mortgage Can Cost You
A closed mortgage is a mortgage where the term of the mortgage is fixed for a period of time. Generally speaking, a closed mortgage will come with a lower interest rate as compared to an open mortgage. While an owner will benefit from lower mortgage payments with a closed mortgage as compared to an open mortgage, the problem arises when you look to pay off the mortgage before the term is up. This can happen when you either sell the property or refinance it with another lender. When you pay off the mortgage prior to its maturity, the lender will charge you a pre-payment penalty. This penalty will usually be the greater of an amount equal to three months of interest or the interest rate differential.
The interest rate differential represents a dollar figure which is the difference between the original interest rate on your mortgage and the interest rate that the lender can currently charge if it were to loan the funds today. Depending on the balance outstanding on your mortgage and the difference in interest rates at the time you signed your mortgage as compared to current interest rates, the interest rate differential can be thousands of dollars. The interest rate differential is calculated by your lender.
If you are considering the sale or refinance of your property and you have a closed mortgage, you should determine the amount of your prepayment penalty and and take this into account prior to selling or refinancing. The amount of the applicable penalty along with commission, legal fees and adjustments will give you a good idea as to the amount of funds you should receive after the sale is completed. Problems may arise in situations where there is very little equity in the property and there is a significant prepayment penalty owing to the lender. In situations like these, the seller may not have sufficient funds to close the transaction unless he or she has other financial resources in the event of a shortfall. If the seller has failed to take into account the prepayment penalty and does not have sufficient cash to close the transaction, the sale may not close leaving the seller exposed to a lawsuit by the purchaser for breach of contract and damages.
In most cases, the seller will not learn of the amount of the prepayment penalty until just before closing. This is because the lender usually provides the discharge statement to the lawyer just prior to closing. It is the discharge statement from the lender which will indicate the amount which is required to discharge the mortgage. This amount will include any applicable prepayment penalty. Therefore, if you are a seller and have a large mortgage and are early in the term of the mortgage, you should ask your lender to advise you of the amount of the prepayment penalty prior to entering into an Agreement of Purchase and Sale.
If you are selling a property and paying off your mortgage as well as purchasing another property and obtaining a new mortgage with the same lender, you may be able to negotiate a reduction in the penalty or have the penalty completely waived by your lender. This will depend on the circumstances and your ability to negotiate with your lender.
It is also important to keep these points in mind when you are purchasing a property. The interest rate being charged by the lender should not be your only consideration when selecting a lender. Different lenders may have different rules or formulas to determine how pre-payment penalties are calculated. You should consult with an experienced mortgage professional who can provide additional information concerning pre-payment penalties and many other important factors regarding your mortgage.
Courtesy: Lorne Shuman, ShumanLaw.ca