Fred sold his house in April 2010, but he’s still fighting with his mortgage lender about the cost of getting out early.
He knew he’d be penalized to break out of a five-year closed mortgage with 26 months left in the term. But he figured he paid $3,000 too much because of the way the penalty was calculated.
The lender used an interest rate of 6.05 per cent, not the 5.55 per cent rate he was paying - the only rate shown in his mortgage document.
Adding a half-point to the so-called discounted rate meant he was charged $13,125, instead of the $10,000 he thought he actually owed.
“As a lawyer, I’m embarrassed at being caught out by such a manipulation,” said Fred (who doesn’t want to use his real name).
“My knowledge of contract law suggests they shouldn’t be able to impose a discount not referenced in the documents.”
I often hear complaints from readers about the way financial institutions calculate penalties for getting out of closed mortgages before the term ends.
Most lenders require paying a penalty of either three months’ interest or an interest-rate differential (IRD), whichever is higher, to make an early exit.
Since rates have dropped in recent years, the IRD – based on the gap between the original rate and the rate for the remaining term, the outstanding balance and the number of months left – is almost always used.
Here’s the problem: Lenders calculate these penalties in different ways. There’s no standardization. Disclosure is minimal.
As a result, borrowers get hosed when they refinance or sell their homes.
Finance Minister Jim Flaherty promised to bring in rules to standardize the calculation and disclosure of mortgage penalties in his 2010 budget.
Why has there been no progress in more than a year? The answer I received made me think that lenders are working to delay implementation.
“As these issues are complex, they are still under development at this time,” said Stephanie Rubec, a finance department spokeswoman, in early March.
“Over the coming months, measures pertaining to mortgage prepayment penalties will be advanced.”
With a federal election coming in May, new rules for IRD penalties will be put off even longer.
So, here are five tips for those taking out mortgages or renewing mortgages in the coming months.
Think twice about taking out a closed mortgage. Get an open mortgage or a variable-rate mortgage that won’t penalize you for leaving early. You can always lock in to a fixed-rate mortgage later if interest rates shoot up.
Consider a three-year term if you’re getting a fixed-rate mortgage. Lenders push a five-year term because it’s more profitable, but they know the average mortgage is held only three years. Life is uncertain, so why tie yourself up and pay a big penalty to leave? Do you know what you’ll be doing in 2016?
Find out if the rate you’re offered is a discounted rate that will be grossed up if you want to leave early. Ask the lender to give you something in writing that lays out the formula used to calculate the IRD penalty (since you rarely find it in your mortgage documents).
Remember that IRD penalties are a moving target. The lender can quote one amount today and a higher amount tomorrow, depending on the time it takes to sell your property. CBC TV news ran a recent story of a man whose penalty had doubled to $33,800 because the calculation had changed over a few months.
Make sure the lender lets you make a prepayment before discharging your mortgage. Most contracts allow prepayments of 10 to 25 per cent of the balance each year without penalty. But unless you ask, you may not be given the option, despite successful class actions against banks in recent years.
In Fred’s case, the lender didn’t apply his prepayment privileges. Luckily, he caught the error and made a $73,000 prepayment on the day the mortgage was discharged.
He had access to the funds because he was buying and selling a property at the same time, but he still had to fight to get the money to the lender.
“Thankfully, I was able to make the maximum permitted prepayment on the day of closing, but only after a last-minute and stressful series of phone calls with my real estate lawyer and the bank,” he says.
Learn from Fred’s experience. The banks are not your friend and their offers of discounted rates can come back to bite you later on.
Finally, use an accredited mortgage broker to find the best product for you and minimize the IRD penalty. They know how to negotiate with banks and they can help you fight for your rights.
Ellen Roseman writes about personal finance and consumer issues. You can reach her at firstname.lastname@example.org.