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The calculation of mortgage penalties (Note: This article is part of a group of articles on the subject of mortgage penalties. It is possible that your question on penalties is better answered in another article. The list of all the articles in the series on penalties can be found at the end of this article.) Two ways are used to calculate mortgage penalties that a lender is going to apply to a mortgage. Since there are two ways, the bank will surely pick the one that yields them a higher earnings. 1. A certain number of months of interest payments (2, 3 and even 6 months). You have to split the interest component of the mortgage payment and multiply it by the number of month’s penalty. Example: If a borrower has a 25 year, $200,000 mortgage at 5.4%, and he pays it off after 30 months. His mortgage payments are $1,209.17, and the interest for the 30th month is $846.18. If the penalty is three months, the total penalty will be $2,538.55 ($846.18 X 3). 2. The rate difference for the balance of the term of the loan. Also known as the rate differential.) This is a bit more complicated to calculate, but it is used when the current rate (in force when you break your contract) is lower than the rate you got when you negotiated your mortgage. In this case, the penalty is figured to represent the differential between the two mortgage interest totals over the rest of the term. An example will explain it better: Example: If we have the same mortgage, $200,000 25 year amortized 5 year mortgage with a rate of 5.4%, the monthly mortgage payment is $1,209.17. If the homeowner breaks the contract after 30 months by prepaying the loan, the lender will charge a penalty because he can now only lend at the current interest rate, which, 30 months after the old loan, is now at 4.75%. Here is the calculation: a. The lender expected to receive a certain amount for the original loan, which was at 5.4%. Using a financial calculator, this amount is figured to be $25,447.16, representing the payment from the 30th month through the 60th month (5 years). b.The amount of interest that that lender can receive today if it lent the money at the rate of 4.75% for the 31 month period (30th payment through 60th payment) is calculated, again using a financial calculator, at $22,250.74. c. The final step is to calculate the difference between what the lender should have earned and what he will earn at the new lower rate. No financial calculator needed for this: $25,447.16 minus $22,250.74 equals $3,196.26, and you have the penalty! Borrowers have a hard time understanding this system. No one wants to pay a penalty on his mortgage! That’s for sure, but all mortgage loans, apart from some unusual types of open mortgages, have penalties for prepayments. The question of penalties includes many aspects which need clear explanation and examples in order to be able to fully understand them.
Article Source: http://www.financemanual.com
Gregory is an Accredited Mortgage Professional (AMP). To get more information on mortgage rates - taux hypothécaire, please visit: Hypothèque - Get a loan
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