With mortgage rates at historic lows and
possibly going lower, does it make sense to early renew with your
lender or leave them altogether for the best rate.
Here are some points to consider:
Breaking your contract early will cost you money, as all lenders
will charge you for breaking the contract you signed.
The lenders, by law, have to describe how they will charge the
penalty in the original mortgage document you signed or were given
at the lawyers office. This document is called Standard Terms and
Conditions, and you probably filed it away in the waste basket.
According to most Standard Terms and Conditions documents, you will
be charged the greater of three months interest penalty OR
the interest rate differential. Whichever amount is the
larger of the two figures, this will be the penalty amount you will
be charged to break your contract.
Three Months Interest Penalty
When would you pay a three month interest penalty?
Most lenders will charge this penalty if your contract is lower
than the current rate for the remaining term (the new rate to
re-lend out the money) or if you are in a variable rate mortgage.
Here is a sample calculation based on an example of $196,960 mtg
balance @ 5.39 with 2yrs remaining:
($196,960 * 5.39 x /100) / 12 x 3 =$2654 (3 mos interest penalty)
Interest Rate Differential (IRD) or Loss of Interest
This is the most costly of the two calculations and in this lower
rate climate this is what most lenders are charging the consumer.
The cost for you is the difference between the interest rate on
your current mortgage contract compared to the rate the lender can
relend the money out to someone else.
Lets look at two scenarios:
Scenario 1
You just renewed your mortgage last year for $196,960 @ 5.94% 5yr
term with 22 yrs remaining amortization resulting in a monthly
payment of $1330.04. The balance at the end of 5yrs would be
$171,445.48
The balance after 1yr is $192,243.35 you would like the rate of
4.19% for a new 5yr term with the 21 years remaining amortization.
In this case the lender will use the best 4yr discounted rate of
4.29 to calculate your penalty.
$192,243.35 x ((5.94-4.29 )/100 / 12 x 1461 days or 4yrs left to
maturity / 365 = $12,697 penalty
Your new finance amount with the penalty included is $204,940 @
4.19 for 5yrs over 21 yr amortization = $1220.21
This would be a monthly savings of $109.83 or $6589.80 over 5yrs.
Your mtg balance after 4yrs would be $178,317.22 and after 5yrs
$170,942.46. You would recoup part of your penalty in the 5yrs and
you would have a slighly lower balance at the end of the new 5 year
term.
It probably would not make sense to redo the mortgage at this time.
Scenario 2
You renewed your mortgage 3yrs ago for $196,960 @ 5.39 5yr term
with 20 yr amortization resulting in a monthly payment of $1336.07.
Balance at the end of the 5yrs would be $165,332.10
The balance after 3yrs is $179,000 and you
would like the rate of 4.19% for a new 5yr term with 17 years
remaining amortization. In this case the lender will use the best
2yr discounted rate of 4.75 to calculate your penalty.
$179,000 x ((5.94-4.75 )/100 / 12 x 1461 days or 4yrs left to
maturity / 365 = $3440 penalty
Your new finance amount with the penalty included is $182,440 @
4.19 for 5yrs over 17 yr amortization = $1248.42
This would be a monthly savings of $87.65
or $5259 over 5yrs.
Your mtg balance after 3yrs would be $158,832.32 and after 5yrs
$141,380.96.
You would recoup your penalty within the first 40 months and your
balance at the end of the 3yr term would save you $6500. It makes
sense to redo your mortgage to save the money.
At the end of the day you need to look at your personal goals and
determine if breaking your current contract for a lower rate will
benefit you and your situation. This is a good time to review your
financing needs.
When it comes to penalty information be advised :
1) The penalty charges you agreed to with your original mortgage
document are not always the same when you your renew with the same
lender. Their policies concerning penalties are always changing.
2) Lenders do not use the exact same calculation. Lenders all have
their own variations on calculating the Interest Rate
Differential
3) Your legal representative or real estate agent is not always
familiar with all the different twists and turns of penalty charges
4) Some lenders will refund the 3 month interest penalty
back if you refinance with them, but most will not refund the
IRD.
