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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.