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How to protect yourself from Mortgage Penalty?

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  • How to protect yourself from Mortgage Penalty?

    Research has shown that over 83 percent of people break their mortgages early, resulting in mortgage penalties that sometimes far exceed the annual interest on a mortgage.

    People break their mortgages early for several reasons, including relocation, the end of a marriage relationship, loss of a job, to take equity out to invest elsewhere and for many other reasons.

    Mortgage penalties are calculated as follows:

    The three-month interest method: Here, you basically calculate the interest due on your next three mortgage repayments and pay the three-month total.

    Interest Rate Differential (IRD): The IRD is calculated by multiplying your mortgage balance by the difference between your original mortgage interest rate and the current interest rate that the lender can expect to charge upon reselling the mortgage.

    To protect yourself from high penalties,
    1. Read your mortgage contract thoroughly: Ensure you find out exactly what penalty you will be expected to pay in case you decide to break your contract early.

    2. Understand, and take advantage of pre-payment clauses
    : Pre-payment clauses allow you to pre-pay up to 20 percent of the balance of your mortgage annually without incurring a penalty. Pre-paying your mortgage allows you to significantly reduce the amount of your mortgage so that you can decrease the penalty you have to pay for breaking the contract.

    3. Ensure that the contract allows you to break your mortgage
    4. Enlist the help of the Ombudsman for Banking Services and Investments Office.
    5. Learn how to calculate the penalties yourself.

    Professionals offering services related to mortgage penalties in Canada could help you decide whether it is worth to break my mortgage contract early?
    Mortgage penalties are in place to protect the lender and ensure they recoup some of the funds they’re losing when you’re no longer paying them interest.

  • #2
    Whoever reads the post above, please note that the contents are for Canada, not for the UK. The rules are different in the UK.

    Here the "mortgage penalty" is called Early Repayment Charge (ERC) and is typically a percentage of the mortgage amount, not equivalent of 3 months interest. The percentage is typically 1-5% of the mortgage amount being repaid early over and above any overpayment allowance. The actual percentage is dependent on the lender and the deal chosen.

    The overpayment allowance is normally 10% per annum, although a few lenders allow even 20% per annum. To note, the allowance is calculated based on the mortgage balance at the beginning of the year.

    For example, if the balance is £100k at the beginning of year 1, then you can pay 10% = £10k in addition to your normal mortgage payments. If you make this overpayment plus your normal mortgage payments and the balance is £85k at the beginning of year 2, then now you can pay 10% = £8.5k in addition to your mortgage payments during the second year.

    There is no Interest Rate Differential in the UK.

    Finally, as most deals only have a penalty (ERC) during the initial deal term (i.e. during the first 2-5 years) and most people don't have the means or the desire to overpay by more than 10% per annum, most people in the UK are not affected by the penalty. Having said this, the mortgage offer and the annual statements always give information about any potential ERC, so it's worth reading these documents.
    Last edited by Lilla D; 13-06-2018, 12:05 AM.
    I am a Mortgage Advisor
    For further information and for tailored advice:
    [email protected]


    • #3
      I have previously been affected by a mortgage penalty because I have been shown how to look after my mortgage and the rules do and don't. I have now been in contact with SJ Financial Solutions. They taught me everything I need to know in regards to a mortgage. Helped me save off mortgage troubles.
      We’re expert financial and mortgage advisors based in Birmingham, UK. Services include first time buyer mortgage advice, buy to let mortgage advice & more.