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Question:
Why should I look closely at prepayment privileges and penalty charges when shopping for a mortgage?
Answer:
“Prepayment” refers to paying more than the regular payments that you are required to make in the terms of a closed mortgage agreement. Examples of prepayment include:
- increasing the amount of your regular mortgage payments
- making a lump-sum payment to reduce your mortgage balance, or pay it off in full
- breaking your mortgage contract.
“Prepayment privileges” refer to the amount that you’re allowed to pay down on a closed mortgage each year, over and above your regular payments, without having to pay a prepayment charge. Privileges are described in your mortgage contract, and they vary from lender to lender.
For instance, one lender might let you make a lump-sum payment each year that is equivalent to 10 percent of the original mortgage amount without an extra charge, while another might let you pay an extra 15 percent as a lump sum, plus increase the amount of your regular payments.
Taking advantage of prepayment privileges will allow you to pay off your mortgage faster and can greatly reduce the amount of interest you will pay over the life of your mortgage. The more you are allowed to prepay, the greater your potential savings on interest.
Prepayment charge: If you have a closed mortgage and want to pay down more than your prepayment privilege allows, you should check your mortgage contract to see if this is possible. If it is allowed, you will probably have to pay a prepayment charge, sometimes called a prepayment penalty.
Prepayment charges can be costly. They are based on factors such as:
- how much you want to prepay
- the number of months left until the end of your mortgage term
- how your lender calculates the prepayment charge.
To reduce the potential for prepayment charges in the future, try to find a mortgage with prepayment privileges that best suit your needs. Think about the most likely situations in which you will make prepayments during the term of your mortgage, and how much you will likely be able to prepay. Then look for a mortgage with prepayment privileges that match.
Look for information about both prepayment privileges and charges as you consider each option you are offered by lenders or mortgage brokers.
If your lender is a federally regulated financial institution, such as a bank, it must outline prepayment privileges and charges, along with other key details, in an information box at the beginning of your mortgage agreement.
By law, it must tell you how the prepayment charge will be calculated. It must also provide you with a description of the components used in the calculation of the charge. This information must be presented in a manner and written in language that is clear, simple and not misleading.
If the calculation is complex, your lender may provide a simplified example, illustration or method to help you estimate the prepayment charge.
Read your mortgage contract carefully to confirm these details before you sign, and ask questions about anything you don’t understand.
Resource(s):
Classification of this FAQ:
| Category | Sub-category |
|---|---|
| Mortgages | Applications |
| Renewing & Renegotiating | |
| Penalties |
Related Question(s):
- What should I consider when choosing between a short-term or a longer-term mortgage?
- What is a “portable” mortgage?
- Does my financial institution have the right to impose a penalty when I renegotiate my mortgage?
- What is an “assumable” mortgage?
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