Calculation of the IRDTo calculate the IRD, your lender typically uses 2 interest rates. They calculate the entire interest fees left to pay on your current term for both rates. The difference between these amounts is the IRD.To do so, they can first use one of the following interest rates:the posted rate at the time you signed your mortgage contractyour current rate or discounted rate as described in your contractYour lender can calculate a second interest rate based on the following:the current posted rate for a term with a similar lengththe current posted rate for a term with a similar length minus the discount you were originally offered
Example of a prepayment penalty calculationSuppose you want to break your mortgage contract to get a new contract with a lower interest rate. You want to estimate how much the prepayment penalty will be.Assume the following:outstanding mortgage balance: $200,000current interest rate: 6%number of months left in term: 36 months left in a 5-year termcurrent posted interest rate for a mortgage with a 36-month term offered by your lender: 4%The approximate fees are:amount equal to 3 months’ interest on what you still owe: $3,000IRD: $12,000
You will have to pay a prepayment penalty of $12,000, which is the higher of the 2 amounts. You may also have to pay an administration fee.Always review your mortgage contract with your mortgage broker to find out exactly how your lender will calculate your prepayment penalty. If you need to break your mortgage always check with your lender to get the actual amount before making any decision. Ask your lender to explain anything you don’t understand.
