In May, I sent an email about a "$14,000 Surprise!". My seller client thought his mortgage payout penalty was about $1,800 because he had a variable rate mortgage. No, he had a fixed rate mortgage with a pretty standard payout clause. That clause basically said that for a fixed rate mortgage, the payout penalty is the greater of three months of interest or the 'interest rate differential.'

Briefly, the 'interest rate differential' means that if a seller pays his mortgage early, the lender looks at whether they can lend the now paid-back mortgage money to a new borrower at a higher interest rate. If the lender can do that within their somewhat complicated calculations, the seller would have to pay three months' interest. If the lender cannot lend at a higher rate, they figure out what they are losing by getting paid back early. That calculation would then be the seller's payout penalty. 

For my seller client, the 'interest rate differential' calculation resulted in a penalty of $14,000 rather than $1,800! This was a disaster because every penny of sale proceeds had been allocated based on $1,800!

Since May, the interest rate environment has completely changed. Interest rates have been rising steadily, and economic predictions say further rate hikes are in store. 

What does that mean for payout penalties?

On a sale that closed this week, my seller was overjoyed! She had been postponing selling because early payback of her fixed rate mortgage (2.29%) would have produced a $16,500 payout penalty. Why? Because the last time she checked, lenders could only lend at less than 2.29%. 

We ordered the usual payout statement from her lender. The payout statement specifically went through a calculation showing the lender would be able to lend the now paid-back mortgage money to a new borrower at just under 6%. The difference between 2.29% and 6% means the lender is not losing any money because of the early payback but actually making quite a bit more by lending to a new borrower.

Therefore, the early payback penalty is three months of interest of about $2,000, not $16,500. My seller client is overjoyed! 

If you have clients who aren't taking action because they thought they had large fixed rate payout penalties, it's time to reassess. Have them order a new mortgage information statement from their lender. Chances are, their large fixed rate payout penalty will now be only three months' interest. They might be ready to take action based on new numbers. 

No matter what, if your client has a mortgage to pay out, get that updated mortgage information statement. Prevent surprises.

Protect yourself.

Cheers,

Barry

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