How are mortgage penalties calculated in Canada?
Mortgage penalties 101
Mortgage penalties in Canada are an expensive travesty and 65% of Canadian mortgage holders pay these penalties annually.
Mortgage penalties are calculated based on the terms and conditions of the mortgage agreement.
The penalty is usually charged when a borrower pays off their mortgage early or breaks their mortgage agreement in some other way.
Yes…you read that correctly. If you were to go into a bank to pay them back the money they lent you…for which you paid interest to them for the privilege…you would then, to add insult to injury, have to pay these bastards a MORTGAGE PENALTY!!
Example: Breaking the mortgage agreement to switch to a different lender or to renegotiate mortgage terms. Any reason will do for these sods to charge you a penalty. Then they’ll charge you a $300 admin fee. Oh…then they’ll charge you a $300 “reinvestment fee”.
You cannot make this crooked shit up.
Types of Penalties
The exact calculation method may vary between lenders, but there are generally three types of mortgage penalties in Canada:
- three-month interest penalty
- interest rate differential (IRD) penalty
- set percentage charge
3-Month Interest Penalty
The three-month interest penalty is typically charged if a borrower pays off their mortgage in full or makes a prepayment that exceeds the allowed amount.
The penalty is equal to three months of interest on the remaining mortgage balance.
This is the standard penalty charge for a variable rate mortgage penalty.
Interest Rate Differential (IRD) Penalty
The IRD penalty is calculated based on the difference between the interest rate on the borrower’s existing mortgage and the interest rate that the lender could earn by lending the money at the current market rate. Basically an impossible sum to calculate yourself. You need the wizards of lending wonder to calculate this one for you as each lending institution has it’s own formula.
The IRD penalty can be the greater of the two penalties depending on where rates are at on the time of contract breakage or renegotiation. Very tricky.
While the 3-month interest penalty is typically found in variable rate mortgage contracts, in fixed rate mortgage contracts, the penalty charged will the greater of the 3-month interest charge or in Interest Rate Differential.
Fixed Percentage Penalty
The fixed percentage charge is far less common but important to look out for when signing a mortgage agreement.
The reason for caution is due to the fact that the fixed percentage tends to be the most expensive penalty to incur.
Fixed percentage penalties are often found in low rate products: you pay a lower rate on the monthly payments but if you need to break the mortgage or renegotiate the terms, this penalty can be shocking.
Which Lenders Have the Worst Penalties?
By far the worst lenders to have to pay a penalty are…surprise…Canada’s biggest banks.
Don’t believe me? Please read this Globe and Mail article HERE
Your big bank will ding you the hardest if you choose to leave or renegotiate. Now, don’t get me wrong…all Canadian lenders are going to screw you on penalties. It’s my job to make sure you get screwed the least.
That’s why I typically try and place clients with fair penalty lenders: these are mortgage companies and to a lesser extent credit unions.
Big bank penalties are often 5X higher than those charged by mortgage companies. Credit Unions are somewhere in between.
Conclusions and Further Thoughts
This next tidbit of information is not going to make you feel better about mortgage penalties…especially if you have recently paid one.
In the US, they don’t have mortgage penalties. You just stroll into the bank, ask how much you owe, then transfer the amount, cut them a cheque or hand over the briefcase. ..see you later.
If you’ve read some of my earlier blogs on banks and the Bank of Canada, you’ll know what I think of these diabolical institutions. Any business that can create money out of nothing (fractional reserve banking) then charge compounding interest on the aforementioned nothing is straight criminal.
At least the Americans have the penalty situation reigned in. Canadians are far too “nice”.