Interest Rate Differential Calculations and How Using a Lender with Posted Rates Will Inflate Your Early Payout Penalty by Thousands of Dollars

Are you in the market for a mortgage? If so, you may be considering working with a lender that advertises their posted rates. While these rates may look attractive, it's important to understand how they can impact the interest rate differential (IRD) calculation. In Canada, lenders are required to publicly post their rates for mortgage products. However, these posted rates can often be higher than the actual rates offered to borrowers. It's important to understand the difference between the posted rate and the actual rate, as this can have a significant impact on your mortgage payments and early payout penalties.

The IRD is the difference between the interest rate on your existing mortgage and the rate that the lender could charge today for a mortgage with a similar term to your remaining term. This calculation takes into account the remaining balance on your mortgage, the time left in your term, and the difference between your original interest rate and the lender's current rate. The resulting IRD amount represents the compensation the lender requires for the lost revenue it will experience if you break your mortgage early.

As a licensed mortgage associate at Audra Kish serving the Saskatoon area, I often encounter clients who are surprised by the hefty early payout penalties they face when breaking their mortgage before the end of their term. One factor that can significantly impact the size of these penalties is the interest rate differential (IRD) calculation method used by your lender. In this blog, I'll explain what IRD is, how it's calculated, and why using a lender with posted rates can lead to inflated early payout penalties.

1. Using posted rates instead of actual rates to calculate IRD

As mentioned earlier, some lenders may use their posted rates instead of the actual rates offered to borrowers to calculate the interest rate differential (IRD). This can result in a significantly higher penalty amount if a borrower decides to break their mortgage early.

2. Failure to disclose actual rates

Lenders are required to disclose the actual rates offered to borrowers, including any discounts or promotions. However, some lenders may fail to do so, leading borrowers to believe that they are getting a better deal than they actually are. This can result in higher early payout penalties if the borrower decides to break their mortgage early.

3. Variable-rate mortgages and posted rates

For variable-rate mortgages, some lenders may use their posted rates as the benchmark to calculate the IRD penalty, even though variable-rate mortgages are typically based on a different benchmark. This can result in an inflated penalty amount if the borrower decides to break their mortgage early.

4. Offering different rates to different borrowers

Some lenders offer different rates to different borrowers based on their credit score, income, and other factors. If a borrower signs up for a mortgage with a lower rate than the posted rate, they may be subject to a larger IRD penalty if they try to break their mortgage early, as the difference between their rate and the posted rate can be significant.

5. The impact of mortgage terms on IRD calculations

The length of the remaining term on a mortgage can also impact the IRD calculation. For example, if a borrower has a longer remaining term on their mortgage, using the posted rate to calculate the IRD can result in a higher penalty amount compared to using the actual rate.

Working with a lender that advertises their posted rates can have significant implications for the interest rate differential (IRD) calculation and ultimately impact the size of your early payout penalty. As a borrower, it's important to understand the difference between the posted rate and the actual rate, as well as how the IRD calculation method may impact your penalties. As always, it's essential to carefully review all the terms and conditions of your mortgage agreement before signing on the dotted line. Working with a knowledgeable mortgage professional can help you navigate the complexities of the mortgage process and make informed decisions that align with your financial goals.