IRD example in The Canadian Press


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IRD example in The Canadian Press

The never ending story of Canadian mortgage “prepayment penalties” is in the news again! It is not a penalty if a lender performs the IRD calculation according to the well known future value technique as outlined by CMHC over 20 years ago. Leonardo of Pisa aka Fibonacci in his famous, “book of calculations” in 1202 AD derived and outlined the well known future value algebraic equation. This is not a new concept for lenders. If you wish to exit your mortgage term prematurely, without a penalty, in order to take advantage of lower interest rates, then you should also expect your lender to lower your GIC rates or someone else’s GIC rates in mid term. Mortgage term rates are traditionally linked to GIC term rates.

If you wish to pay fair compensation to a lender to prematurely exit your mortgage term then the IRD calculation based upon the future value technique is fair to both the lender and the borrower.

The screen capture image is proof, that if the proper IRD is added to the $100,000 mortgage and continued for 24 months, with the lower interest rate and with the same monthly cash flow the borrower ends up with the same outstanding balance and NOTHING has been gained by the borrower or the lender (the outstanding balance after the 24th payment is within 3 cents of each other).

You will notice in the analysis of this newspaper example the $5000 “penalty” is in excess of the proper value of the IRD, thus the lender is paying a premium to exit this mortgage. The newspaper article’s crude IRD calculation is quick and easy but inaccurate and as usual in the lenders favour!

If anyone doubts this analysis ask any University Professor of Mathematics if this analysis is correct.