The world of mortgages and real estate is filled with an excessive amount of acronyms. If you were to overhear some of our conversations, you would swear we were speaking a different language – LTV and PMI this, and IRD and ARM that, API, BPS, and it goes on and on. While most people don’t really need to bother to learn what most of these mean, if you currently have a mortgage, one of the acronyms you should know is IRD (Interest Rate Differential). This is the charge that may apply if you pay off your mortgage prior to the maturity date, or pay the mortgage principle down beyond what you’ve set up as a pre-payment privilege.
Basically, if you’re going to break your mortgage early, the IRD more or less represents the profit the lender was going to make on your mortgage had you not broken it early – and it’s what you’re going to pay them so that you can break it early. This penalty can be tens of thousands of dollars, so before you break your mortgage (whether it’s to refinance, to get a lower rate, or to buy a new house), you need to make sure you know what your IRD is ahead of time.
The IRD is calculated based on the amount you are pre-paying and an interest rate that equals the difference between the interest rate on your current mortgage, and a comparison interest rate that the lender would charge today to re-lend the funds out for the remaining term of your mortgage. So if you have 3 years left on your mortgage, that comparison rate would be the interest rate the lender currently has for their 3-year term, or if you have 10 months left on your mortgage, they would usually round up to what their current 1-year term rate is. Of course, just to keep it interesting for all involved, each lender has its own formula for calculating penalties (some round up, some round down, some seem pretty close to random), so the best way to find out what your current IRD is, is to simply call up your lender and ask.
While most variable-rate mortgages do not have IRD penalties (since a variable-rate mortgage is, well, variable, it always adjusts to current market conditions), most closed, fixed-rate mortgages have a pre-payment penalty that is the higher of 3-months interest or the IRD.
Wo what’s the best way to find out if it’s worthwhile to break your current mortgage for better rates or for a refinance? Call your current lender and ask them what your IRD would be if you broke your mortgage today (they’re the ones who are going to charge the penalty – they’re the best ones to ask what that penalty will be), then call your favorite mortgage broker and let them figure the rest out for you. 😉 Once we know what your IRD is, we can let you know if it’s worth your while to break your mortgage right now, or wait until your IRD gets a little smaller.
