How to calculate Mortgage Penalities (hypotheque)

The calculation of mortgage penalties

(Note: This article is part of a series of articles on the subject of mortgage penalties. It is possible that your question on penalties may be better answered in another article. The list of all the articles in the series on penalties can be found at the end of this article.)

Home loan lenders use two methods to calculate the penalty and, since there is more than one method, you can be sure they will use the method that yields a higher amount for them

1. Interest times number of months. (2, 3 or 6 months.) First you have to segregate the interest payment of the mortgage from the principal portion and multiply it by the number of month’s penalty.

Example: If a borrower has a 25 year, $200,000 mortgage at 5.4%, and he pays it off after 30 months. His mortgage payments are $1,209.17, and the interest for the 30th month is $846.18. If the penalty is three months, the total penalty will be $2,538.55 ($846.18 X 3).

2. The difference between the rates for the rest of the term. (Also know as the rate differential.) This calculation is a little complicated but it is used only when the effective rate (when you break your mortgage contract) is lower than the rate that you have negotiated on your mortgage contract. The penalty is equal to the difference of the interest payments between the two rates for the rest of the term. I believe it is easier to understand this with an example.

Example: If we have the same mortgage, $200,000 25 year amortized 5 year mortgage with a rate of 5.4%, the monthly mortgage payment is $1,209.17. If the homeowner breaks the contract after 30 months by prepaying the loan, the lender will charge a penalty because he can now only lend at the current interest rate, which, 30 months after the old loan, is now at 4.75%.

Here is the calculation:

a. The lender should have received a certain amount on this loan based on the original rate of 5.4%. Using a financial calculator, the lender determines this amount to be $25, 447.16, which represents the payments from the 30th month through the 60th month, or five years.

b. Now the lender figures the amount of interest that will be received on a new mortgage, at the current rates of 4.75%. A financial calculator is required for this calculation, and it is figured at $22,250.77.

c.The differential between the interest payments received by the lender is $25,447.16 less $22,250.74 or $3,196.26. There is your penalty!

Borrowers have a hard time understanding this system.

No borrower wants to pay a penalty on his mortgage! That’s for sure, but all mortgage loans, apart from some rare types of open mortgages, have penalties for prepayments. The question of penalties includes many aspects which require clear explanation and examples in order to be able to fully comprehend them.

By: Gregory van Duyse
Credit:www.superfeature.com