Is Interest Rate Differential Holding you Back from Refinancing your Mortgage Now at a Great Rate?

Many Canadians are wanting to take advantage of today's low mortgage rates, but are afraid of the high Interest Rate Differential penalty that their lending institution will impose should they refinance early.

However, homeowners should be doing a careful analysis before they completely reject a mortgage refinance based on the penalty charge!  Interest rate differential is a penalty calculation to reimburse the existing lender for any loss of interest they may have if you terminate the mortgage early.  The IRD penalty can be a lot of money, but the potential interest and cash flow savings likely out weigh the costs.

Here is an example:  Mr. & Mrs. Brown have $197,500 remaining on a mortgage term at 5.99% interest.  They have 21 months until this mortgage comes due for renewal.  They wish to take advantage of a 3.89% interest rate which is available to them today, with a lender who offers a "No-Fee Refinance" (free legal services and appraisal).  The IRD penalty the lender would impose is $9,124.50!  (They would compare their two year interest rate of 3.35% to the 5.99% the Brown's are paying to calculate the IRD).  Also, they would have to increase their mortgage amount by $10,000 to cover this penalty and a top up of their insurance premium on the increased mortgage amount.  This seems imposing, but is it really?

Mr. & Mrs. Brown think that interest rates will be back up to "normal mortgage rates" in 21 months.  Having asked them to predict what they think rates will be in 21 months on a 5 year fixed rate mortgage, they agreed that rates could be as high as 5.25% when their mortgage comes up for renewal.

So let's examine the cost of this refinance: 

Over the next 21 months the Browns would pay their existing lender a total of $20,254.97 in interest (at their current 5.99% mortgage rate).  Comparing the same amount ($197,500) with the new lender, they would pay $13,827.47 in interest at 3.89%.  We have already recovered $6,427.50 of the penalty in interest savings.

Now let's take a look into the future.  Assuming the Brown's lock into a 5 year term at 3.89% today, at the time of renewal of their old mortgage (in 21 months) they are guessing that their old mortgage lender will offer them a renewal at 5.25% interest for the next 5 years.  At the end of their existing mortgage term, their mortgage balance would be $190,191.88.  Refinancing that amount at 5.25% interest would result in $31,355.86 in interest payments over the next 39 months. 

Should they refinance now at 3.89%, in 39 months they would owe $200,850.70.  This same amount at 3.89% would pay $24,453.19 in interest - an additional savings of $6,902.67.  In total their interest savings would be $13,330.17 over the next five years.

A further analysis showed that the Browns mortgage payment would be reduced by $327.83 per month - a cash flow savings of $19,669 over the next 60 months, making the total savings (interest paid and cash flow savings) to be $32,999!  This makes the IRD penalty not as bad looking!

Further savings could be made if the Browns elected to keep their mortgage payment the same and refinanced at the 3.89% interest rate.   This would have the effect of increasing their interest savings and reducing their amortization significantly. 

Our Accredited Mortgage Professionals can do a free, no-obligation refinance savings analysisfor you.  Simply apply online and see how much you can save!