Many closed mortgages include a clause stating that the payout privilege on the mortgage will be a three-month interest penalty, or interest differential, whichever is greater.
For the calculations below, we’ll use the following scenario:
- $300,000 remaining on the mortgage
- 3 years into a 5-year fixed term at 5.5%
- Today’s interest rate: 3.5%
We’ll just be using the simple interest amount – the actual amount of the penalty would be a little less than the amount quoted in the examples.
Three Month Interest Penalty
Plugging in the variables above, we would get:
= $300,000 X 0.055 X 0.25 (5.5% = 0.055, 3/12 = 0.25)
= $4125.00 would be the 3 month interest penalty
But now we have to calculate the interest differential – and that’s where it can get nasty – especially since interest rates have dropped considerably lately.
Interest Differential Penalty
=$300,000 X 0.02 X 2
(0.02 = 2% which is the difference from 5.5%-3.5%, and 2 years left in term)
=$12,000.00 would be the Interest Differential Penalty
In our example, the bank would then use the Interest Differential Penalty since that amount is the greater of the two. Please speak to your mortgage specialist for your personalized mortgage advice, as payout penalties are dependant on the contract you signed.