• On a fixed rate mortgage you will pay the greater of three months interest or interest rate differential, IRD for short.

• On a variable mortgage you will only pay three months’ interest.

 

The IRD is a compensation charge that may apply if you pay off your mortgage prior to the maturity date, or pay the mortgage principal down beyond the amount of your prepayment privileges.

 

The IRD is based on:

1. The amount you are pre-paying; and,

2. An interest rate that equals the difference between your original mortgage interest rate and the interest rate that the lender can charge today when re-lending the funds for the remaining term of the mortgage.

 

Example of penalty

You purchase a house for $500,000 and the initial mortgage balance is $300,000.  Original amortization is 25 years and the product is 5 year fixed rate of 3.5%.

Two years later you decide to payout the entire mortgage amount (ie sell) and at that time the outstanding balance is $284,387.46

 

• You are two years into the five-year term of 3.5%, therefore 3 years remaining.

• Lender’s current 3 year rate is 3.1%

• Differential is .4%  (3.5%-3.1%)

 

Remember, penalty for fixed rates (except terms Greater than 5 years) is 3 months interest or IRD, whichever is greater.

 

3 months interest penalty

• $825.43 times 3 = $2476.29

• Refer to amortization schedule

 

IRD penalty

Outstanding balance times interest differential times years remaining

          $284,387.46 times .4%  times 3 equals $3412.65

After both penalties have been calculated we must select the greater, in this case IRD, at $3412.65.

 

Things to note

• The above penalties are approximate.

• Each lender has its own formula for calculating penalties.

• A small number of lenders prohibit breaking a mortgage early—regardless of the penalty—unless in the case of an approved bona fide sale.