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An IRD is not a mortgage penalty

Here we go again. The never ending story of confusion concerning Interest Rate Differentials (IRD).  Caveat! I am not a mortgage broker. I am not a big fan of Banks! However to be fair to Banks, the IRD if calculated correctly is not a mortgage penalty. It is a fair method of compensation to a Bank for allowing a borrower to prematurely exit a mortgage term. A Bank’s mortgage term rates are traditionally tied to depositors guaranteed financial vehicles.

 The IRD calculation is based upon well established future value calculations developed in 1202 AD by Fibonacci in his “book of calculations”. So much for history. Perhaps the appropriate financial government ministries and the banks should study history. I cannot understand why Industry Canada’s website is now in the mortgage calculator business? Besides, their calculator according to this latest newspaper article (Protecting your biggest investment) gives incorrect numbers.

To use the newspaper example, the correct IRD should be $9,169.08 not the “about $12,000” as mentioned in the article. If the correct IRD is added to the $200,000 balance and the lower rate of 3.5% is used for the next 30 months (instead of the 5.5%) using the same monthly payments,  the outstanding balance at the end of 30 months is the same (within 11 cents) which is what the IRD is intended to achieve. It is interesting to note that the IRD calculation is really nothing more than a mortgage discount calculation that virtually every registered professional mortgage broker knows how to perform!

An amortization period of 25 years was used as a basis in arriving at $9,169.08,  however the $12,000 IRD from the Federal government’s web site is incorrect no matter what amortization period is chosen. If 35 years had been used the correct IRD would be $9,277 and if 15 years had been used the correct IRD would have been $8,884. The point I am trying to emphasize is Canadians should expect a standard method for calculating the IRD. If the Federal and/or Provincial governments are going to provide financial standards then they should get it right and be consistent on “help” websites and legislation! Anyone using that government calculator and its approximate numbers would be out by approximately $2831 which is a significant amount of money. An error of  five  or ten dollars, on a $200,000 mortgage I can live with but not $2831. Too many chefs spoil the broth, does come to mind!

 

 


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