Understanding Mortgage Penalties: Types and Implications

In contrast to conventional mortgages, which have fixed terms, reverse mortgages are based on the duration you've held the mortgage. If you intend to stay in your home indefinitely, such as a typical purpose of a reverse mortgage, penalties may not be a concern. Moreover, penalties are often waived after 10 years with most reverse mortgage lenders.

Here are some examples to illustrate the differences in penalties between different mortgages products.

• Open mortgage products, as the name suggests, offer a high degree of flexibility. No Penalty. These mortgages allow borrowers to make prepayments (paying off the mortgage early) without incurring significant penalties. Generally, there are no prepayment charges for open mortgages, which means you can pay off the entire mortgage balance at any time without any financial penalty.

• Conventional Fixed rate mortgage products: Penalty is usually based on Interest Rate Differential (IRD). Fixed rate mortgage products come with specific penalties if you decide to break the mortgage term before it matures. The most common penalty calculation is the Interest Rate Differential (IRD) penalty. This penalty is calculated based on the difference between your contracted mortgage rate and the current rate the lender can offer on a mortgage term that matches your remaining term. The IRD penalty is often higher if you break the mortgage earlier in the term, and it's intended to compensate the lender for the lost interest income due to early repayment.

• Conventional Variable rate mortgage product: There is usually a Three-Months' Interest Penalty. Variable rate mortgage products tend to have a less severe prepayment penalty structure. The penalty for breaking a variable rate mortgage early is often limited to a relatively low cost, typically equivalent to three months' interest payments. This penalty is generally less expensive than the IRD penalty associated with fixed-rate mortgages.

• Reverse Mortgage Penalty. For regular mortgages, you can often pay off the mortgage at the end of any term without a penalty. In contrast, reverse mortgage penalties are determined by the duration you've held the mortgage. Some lenders may offer a one-time penalty-free option at the end of year 5, while others follow the usual 5-year penalty. Penalty options varies a lot between the lenders offering reverse mortgage products.

In summary, reverse mortgages calculate penalties based on the duration of the mortgage, rather than fixed terms and rates like regular mortgages. If you plan to keep a reverse mortgage for a short period, penalties should be a consideration. However, if you intend to stay in your home for an extended period, such as a lifetime or at least 10 years, you likely won't need to worry about penalties.