Lots of my conversations over the past week have been around IRDs and how they are affecting your deals, especially refinances. Some have said they have the deal set to go and then get the payout from the lender and the penalty is so high it kills the deal.
How do you work to avoid this (and help maintain your funding ratio)? Easy, do an “estimated IRD” calculation of your own. Here is how:
Calculate the difference in the rate your client is currently paying and their current lenders rate today. (I will give an example later.) Multiple that difference in rate by their current balance. Take that answer and divide it by 12 and multiple it by the number of months remaining on their current term. And there you have it, a “ballpark” simple interest IRD calculation that will help you.
Here is an example:
Client’s rate: 5.5% (original term 5 years)
Remaining term: 44 months
Current rate offering: 4.0% on 4 years
Current mortgage balance: $150,000
$150,000 x 1.5% (5.5% minus 4.0%) = 2250 divided by 12 = 187.50 x 44 (months left) = $8250 approximate penalty
But hold on…
…there are many factors to calculate into this.
· Does the current lender use the rate on the mortgage (5.5% as above) of the posted rate/bond rate/ceiling rate at the time the mortgage closed?
· Do they use the fully discounted current rate on remaining term or the original tem (most use remaining term, so if your client had a 5 year rate, but on has 44 months remaining, the lender might use the 3 year or 4 year rate to calculate the IRD)?
· Do they make the client prepay their privilege payment prior to calculating the penalty, or automatically deduct it?
Each of these factors and change that penalty greatly and knowing the original lender’s policy does help with these variable. Also, if you get a penalty today, and rates go down tomorrow, the penalty will likely be recalculated based on the lower rate.
Most important, this is only a estimated guess. Always get your client to verify the penalty with the current lender. But it is a good practice to do this prior to sending a deal out to the lender, getting an approval, only to have your client cancel the deal once they see the penalty, and having your funding ratio affected by this.
