This is one of the most difficult and controversial topics related to mortgages. However, below is a general overview on how penalties work.
Most lenders charge an early payoff penalty on closed mortgages if the debt is paid prior to the maturity of the term. The lending institution must describe the penalty they could charge on the mortgage document.
The most common penalty is:
The greater of three months interest penalty OR the interest rate differential.
In other words, whichever amount is the larger of these two figures will be your penalty.
One very important point of mention is what when you are calling your lender to find out what your mortgage penalty will be upon payout (for a refinance) make sure you ask your lender to provide you with the penalty amount AFTER taking into consideration your pre-payment allotment for the year (usually about 20% of your total mortgage balance). You will be using the proceeds from your new, refinanced mortgage to pay your pre-payment allotment and you should make sure that you aren’t charged for that amount. Lenders generally won’t take the pre-payment amount into consideration unless specifically asked too and it can make a significant difference in your penalty amount.
If you are paying off your mortgage before the maturity date, most lending institutions charge three months interest penalty (or an interest differential penalty).
Your present mortgage balance is multiplied by your current interest rate and multiplied three.
This usually means the difference between the interest rate on your mortgage contract compared to the rate at which the lending institution can re-lend the money.
For example:
If your mortgage has a balance of $125,000 at 9.25%, you have 2 years left to go and the current 2 year mortgage rate is 6.25%. Then the lending institution will probably charge you -
$125,000 X 24 months X 3% (9.25 - 6.25) = $7,266.21
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