Amy Coburn, Mortgage Broker
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Why do mortgage pre-payment penalties rise as rates fall?
And why some borrowers are still breaking their mortgage early
With fixed mortgage rates trending lower in recent weeks, some homeowners are starting to wonder if it’s worth breaking their mortgage to lock in a better deal, and we’re reviewing the potential savings with more and more homeowners.
But before making any moves, there’s one important thing to understand: your prepayment penalty could be higher than you expect—especially if rates keep falling.
Here’s why that happens, and what it could mean for you.
The basics: How mortgage penalties are calculated
If you have a variable-rate mortgage, your prepayment penalty is usually straightforward: it’s likely three months’ worth of interest. But if you have a fixed-rate mortgage, your lender will typically charge you the greater of:
- Three months’ interest, or
- The Interest Rate Differential (IRD)
The IRD is where things may get tricky – and more costly. In its most general sense, it’s based on the difference between:
- Your current mortgage rate, and
- The rate your lender would charge today for a new mortgage with a similar remaining term.
Why do penalties go up when rates come down?
When interest rates fall, the IRD tends to get bigger. That’s because your existing mortgage rate is likely higher than the current rates your lender is offering. The bigger that gap, the more your lender loses if you break your mortgage early – and the higher the penalty you’ll pay.
In short: when rates fall, the cost of breaking your fixed mortgage can rise.
With fixed mortgage rates already down sharply from their peak – and potentially heading even lower – IRD penalties are becoming a real concern for borrowers who locked in during the rate spike of 2022 and 2023. As the gap between your current rate and today’s lower rates grows, so does the cost of breaking your mortgage early.
Some lenders calculate IRD penalties using the rate difference between your existing mortgage and a current rate for a comparable remaining term. In some cases, especially with today’s unusual yield curve (where shorter-term rates may be higher than longer-term ones), this can result in even steeper penalties than borrowers expect.
What you can do
Before making any decisions about refinancing or breaking your mortgage early, it’s worth getting a penalty estimate, which I can help you with. Some lenders post online calculators, but they don’t always tell the full story – especially since penalty calculations can vary widely from lender to lender, so it’s important to get an expert to walk you through it.
If you’re wondering whether it makes sense to break your mortgage early and take advantage of lower rates, I can help you crunch the numbers.
Let’s chat before you make a move – it could save you hundreds or thousands of dollars in interest and could reduce your monthly cost!
Amy Coburn
Mortgage Broker
(289) 755-0146
amy@amycoburn.com
