What is the Early Exit Fee for Mortgage?

What is the Early Exit Fee for Mortgage? Understanding Early Exit Fees for Mortgages in Canada

Many people dream of owning a home in Canada. It’s a significant financial commitment, and securing a mortgage is often a crucial step in making that dream a reality. However, unforeseen circumstances can arise, prompting homeowners to consider exiting their mortgage agreement early. This might involve refinancing with a different lender, selling your house before the term ends, or making a lump-sum payment that exceeds the permitted amount.

What are Early Exit Fees?

Early exit fees, also known as prepayment penalties, are financial charges imposed by lenders if a borrower breaks the terms of their mortgage contract by paying off a significant portion of the principal or switching lenders before the end of the term. These fees compensate lenders for the lost interest income they would have earned if the mortgage had been paid according to the original schedule.

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Why Do Lenders Charge Early Exit Fees?

From the lender’s perspective, mortgages are a source of income. They offer loans at a specific interest rate, and they expect to earn that interest over the entire term of the mortgage. When a borrower exits the mortgage early, the lender loses out on that anticipated income. Early exit fees serve as a form of compensation for this lost revenue.

How Much Are Early Exit Fees?

The amount you’ll be charged for exiting your mortgage early varies depending on several factors, including:

• The type of mortgage:

  Fixed-rate mortgages typically come with higher early exit fees compared to variable-rate mortgages. This is because lenders lock you into a specific interest rate with fixed mortgages, and if market rates decrease significantly, they may lose potential income if you refinance with another lender offering a lower rate.

• The remaining term of your mortgage:

  The closer you are to the end of your mortgage term, the lower the early exit fee will generally be. This is because the lender has already received a substantial portion of the interest they were expecting.

• The amount being prepaid:

  The larger the lump sum payment you make towards your principal, the higher the potential early exit fee.

• The prepayment penalty calculation method:

  There are two main methods lenders use to calculate early exit fees: the interest rate differential (IRD) method and the three months’ interest method. The IRD method compares the interest rate on your current mortgage to the current market rates. The lender will charge you the difference between what they would have earned on your mortgage and what they can earn by reinvesting the prepaid amount at current market rates. The three months’ interest method simply charges you the equivalent of three months’ worth of interest on your remaining mortgage balance. Lenders will typically use the method that results in a higher fee for them.

It’s important to carefully review your mortgage agreement to understand the specific terms regarding early exit fees. The agreement will outline the calculation method used by your lender and the applicable fees based on the remaining term of your mortgage.

Ways to Minimize Early Exit Fees

While early exit fees can be a significant financial burden, there are a few ways to minimize their impact:

• Negotiate your mortgage terms:

  When you’re initially negotiating your mortgage with a lender, you may have some flexibility in discussing the terms of the prepayment penalty clause. You might be able to negotiate a lower fee or a shorter period during which the fee applies.

• Choose a mortgage with a shorter term:

  Mortgages with shorter terms often come with lower prepayment penalties. This is because the lender’s risk of losing out on interest income is reduced with a shorter repayment period.

• Consider a low-penalty mortgage:

  Some lenders offer mortgages with lower or even waived prepayment penalties. These mortgages typically come with a slightly higher interest rate to compensate the lender for the reduced prepayment penalty income.

• Plan your prepayments strategically:

  If you anticipate needing to make a lump-sum payment towards your mortgage, try to time it for when the early exit fee is lower. For example, you might wait until you’re closer to the end of your mortgage term when the prepayment penalty is likely to be reduced.

Alternatives to Early Exit Fees

In some situations, there may be alternatives to paying an early exit fee:

• Porting your mortgage:

  If you’re selling your current home and buying a new one, you may be able to port your existing mortgage to the new property. This means transferring the remaining balance and terms of your current mortgage to the new home. Porting your mortgage typically incurs a porting fee, which is usually significantly lower than an early exit fee. Not all lenders offer mortgage porting, and it’s important to check with your lender to see if this option is available.

• Negotiating with your lender:

  If you have a good relationship with your lender and a legitimate reason for needing to exit your mortgage early, they may be willing to negotiate a lower prepayment penalty or even waive the fee entirely.

Conclusion

Early exit fees can be a significant factor to consider when making decisions about your mortgage. By understanding how they work, the factors that influence their cost, and the options available to minimize them, you can make informed choices throughout your mortgage term.

Here are some key takeaways:

• Early exit fees compensate lenders for lost income if a borrower exits their mortgage early.

• The amount charged depends on the type of mortgage, remaining term, prepayment amount, and calculation method used by the lender.

• Carefully review your mortgage agreement to understand the specific terms regarding early exit fees.

• Strategies to minimize early exit fees include negotiating your mortgage terms, choosing a shorter term or low-penalty mortgage, and planning prepayments strategically.

• Consider alternatives like porting your mortgage or negotiating with your lender depending on your situation.

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Conclusion

Consulting with a mortgage professional can be invaluable when navigating early exit fees and exploring your options. They can help you understand the specific implications for your situation and recommend the best course of action based on your financial goals.