This section demonstrates where lenders obtain a large amount of their profits and how you can avoid getting caught in their trap.
Whenever the topic of mortgages comes up, all I hear about are rates.
Yes, rates are important.
As a mortgage broker, I have access to a wide variety of lenders including big banks, credit unions, private mortgage companies and other specialized sources of finance.
Because of this access, a great rate is not hard to find.
Did you know however that the way lenders make the most money off of you may not be from the interest rate?
They make their money from pre-payment penalties.
These penalties are rarely explained adequately when borrowers sign their mortgage contracts.
What is a mortgage pre-payment penalty mean to you?
First, penalties have nothing to do with you making your payments on time.
Rather, if you took out a mortgage with a five-year term (which is by far the most popular mortgage term in Canada) then had to sell the property before the end of the 5-year term, the lender would charge you a pre-payment penalty to compensate them for the interest amounts they will no longer be receiving from you.
Boring but important statistic…
• 65% of Canadians break their mortgage at some point during the term and pay a penalty.
This is where lending institutions really make a lot of their money. Don’t believe me? Just Google “Canadian Mortgage Penalty Lawsuits”. Huge penalties, unhappy customers.
What is a mortgage penalty?
A mortgage penalty compensates a lender for the interest payments it loses out on when you break a mortgage contract. The problem in Canada is that this practice tends to overcompensate lenders and is punitive to consumers. Luckily, not all lenders charge penalties in the same way.
Typically, your mortgage penalty will be the greater of three months interest or the Interest Rate Differential (IRD). If you are facing a massive mortgage penalty, the IRD penalty is usually responsible.
4 Ways Mortgage Penalties Are Calculated
Let’s demonstrate each by using a 5-year fixed rate mortgage of 3.2%, current balance of $300,000 and 26 months remaining in your term.
3-MONTH INTEREST CALCULATION
((3.2%/12) x $300,000) x 3
STANDARD Interest Rate Differential (IRD) CALCULATION
(Your existing mortgage rate – Lender’s current rate that most closely matches your remaining term) x mortgage balance x remaining term = (3.2% – 2.69%)/12 x $300,000 x 26
Since this standard IRD penalty of $3,315 is greater than the 3-month interest penalty ($2,400) you’d be charged the $3,315.
DISCOUNTED IRD CALCULATION
This is where lenders start to get tricky…
[Your existing mortgage rate – (lender’s POSTED rate that most closely matches your remaining term – original discount you received) ] x mortgage balance x remaining term = [3.2% – (2.9% – 1.3%)]/12 x $300,000 x 26
Brutal – a little calculation manipulation and your penalty has jumped over $7,000! Wait, the next calculation is even worse.
POSTED IRD CALCULATION
Let’s say 5-year posted rate was 5.1%. Lenders today could argue that the comparable 2-year posted rate today is 2.69%.
(five-year posted rate offered when you got your mortgage – comparable posted rate) x mortgage balance x remaining term = (5.1% – 2.69%)/12 x $300,000 x 26
***So, on a typical $300,000 mortgage, the mortgage payout penalty with certain lending institutions can cost over $15,000 while the same mortgage payout penalty with another institution could be under $3,500.***
Yes, mortgage penalties suck all around.
The focus at Huber Mortgage is on getting you financed from lending institutions that have great interest rates AND charge low penalties.
Money saved – all the way through your mortgage term or if you sell.
Let me show you how to avoid paying thousands in mortgage related penalties.
Financial Reality Shift
Let’s assume throughout the life of your mortgage you end up saving money in one of these scenarios.
Let’s say you save money once by avoiding a large mortgage penalty because you opted to get your
mortgage through a lender with low penalties.
Say you save $12,000 like in the example above. Then, you invested this savings into an investment earning 3%/year.
After 20 years this investment will be worth $21,673.33. That’s growth of $9,673.33 on top of your initial investment of $12,000.
Let’s do everything we can to keep money in YOUR pocket and out of the lender’s pocket.
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