- 1). Review the contract to see if it includes an early payoff penalty. Generally, this is a three-month interest penalty. To calculate your penalty, multiply your current mortgage balance by your current interest rate and divide by 4.
Say you have a balance of $300,000 on your mortgage and your current interest rate is 7.45 percent. To find your three-month interest penalty, simply multiply $300,000 by 7.45 percent to arrive at $22,350. Divide by $22,350 by 4, and you'll see that your prepayment penalty comes to $5,587.50.
Another way the bank may try to recoup lost interest revenue as a result of your paying off your mortgage is through an interest rate differential penalty, in which the bank compares the interest rate on your mortgage against the rate at which it could relend the money on a comparable term. Staying with the example given above, let's say you've got three years left on your contract. The bank would compare your rate with the current three-year rate, which we'll arbitrarily set at 4.25 percent, and so would charge you $300,000 times 3 times 3.2 percent (7.45-4.25). The wallop to your wallet is considerable under this penalty: $28,800. - 2). Get your ducks in a row before you decide to move forward with breaking your mortgage contract. Determine the number of months (or years) remaining on your current mortgage; your balance; your monthly payment; and your interest rate. Weigh the results against the penalty for breaking your current mortgage contract; a lump sum payment to reduce your old mortgage; the annual interest rate of your new mortgage; and the desired monthly loan payment. This should tell you whether you will gain or lose money by breaking your mortgage contract.
- 3). Review your mortgage agreement to see if you can minimize the amount of the penalty you may have to pay. Your lender may offer a prepayment option that allows you to pay up to 20 percent or more of your mortgage; if so, you may want to do this before renegotiating a new mortgage agreement so that the penalty will be calculated on a lower outstanding balance. If coughing up 20 percent on the balance is outside of your means, see if your lender will allow you to extend the length of your mortgage before the renewal date so you can take advantage of lower rates through creation of a new blended-rate and longer-term mortgage -- a "blend and extend" option.
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