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September 5, 2017

IRD – Interest Rate Differential

When you meet your banker to sign for your mortgage you probably don’t have enough time to read through the entire document, and even if you did it is unlikely you would understand it all anyway. Similary when you meet with your lawyer s/he is also unlikely to go through the entire document but will rather focus on key elements, some of which may not seem all that important at that time. After all your mind is most likely focused on the new house or the monthly payment terms.

Nonetheless, one of the key quesions you should ask is “what does will it cost me to get out of the mortgage early?” You may be required to pay the IRD (Interest Rate Differential) as a penalty. The IRD is basically an interest prepayment charge that is calculated as follows:

The prepayment charge on a fixed-rate mortgage is the “greater” of

  • Three months’ of interest on the amount prepaid at the agreed (posted) interest rate; or
  • The total interest for the remainder of the term on the mortgage, calculated using the “interest rate differential” (IRD).

The interest rate differential is the difference between the interest rate and the institutions posted rate calculated on the prepayment date for a mortgage with a term similar to the time remaining in the term and having the same prepayment options as the mortgage less your rate reduction.

In completing this calculation one of the components used is a financial concept called “present value”.  This concept recognizes that interest income to be received in the future is less valuable than the same amount of money received today.  The interest rate differential calculation also takes into account the fact the mortgage balance for the remaining term declines on each payment date.  Nonetheless, the total amount of interest you are required to pay to get out of a mortgage before the end of the term can be very costly indeed.

If you are contemplating an insolvency proceeding (either a proposal or a bankruptcy) your trustee will want to know how much equity there is in your property at the time of filing. In order to help your trustee to help you it would be useful for you to ask your lender to provide you with a “payout statement” as if you were actually going to sell, so that you can see the total cost of the penalties that you would be assessed.