Mortgage Penalties - Are Canadians getting a fair deal?

When you signed your mortgage contract did you sit down and fully read through everything or, did you do what most people do, rely on your mortgage specialist to explain the ins and outs of your debt? I would suggest you take some time and read it through toughly. In the end I think you will agree it isn’t exactly a two way street.

I think we all understand the charges for NSF, missed payment or late fee’s but the real scorchers are the ones that come when you are looking to get a head or just looking to get out!

For instance, let’s say you sign a 5 year mortgage of $300,000 at a fixed rate of 5.69%. 3 years go by and a friend tells you they just locked in at 3.59%. Obviously you would want to make the switch right? Well to do so you will be looking at paying a hefty fee to part with your lender.

How about if you run in to tough times and are struggling make the payments. You decide to sell, rent for a few years and get back on your feet. Lucky for you the market is good and you‘re in a position to sell and turn a profit!

Hold on - You have 2 years remaining on your term. The bank could hit you with a breakage penalty of anywhere between $5,000 to $14,000 dollars. It may make you think twice about what you want/can to do.

Pre-payment penalty charges are well stipulated in your mortgage document. The amount depends on many factors, however, for fixed rate mortgages they are calculated using the IRD method (Interest Rate Differential) and usually come to thousands of dollars. I was personally faced with this a few years back. If we decided to payoff and close our $170,000 mortgage we would have to pay a penalty of $8,600. We decided to port the mortgage and bring it to our next property.

If you ask the banks to explain the reasoning behind these fees they will most likely tell you they need to collect a portion of the interest the bank would’ve made if you stayed on until the end of your term. Makes sence right? In other words the contract that is signed when you opened your mortgage is an agreement that holds risk for both yourself and the bank and the bank needs to realize the benefits of the contract.

Let’s break this down:

1.      Lendy Equity Inc. does its due diligence and approves Jane Doe for a mortgage of up to $350,000 and offers her a rate of 5.69% on a 30 year amortization loan.

2.      Being the conservative lady Jane looks and finds a home for $300,000. She has saved $20,000 to be put towards her new home and heads to the bank!

3.      Jane decides she will put down the $15,000 (5% the Canadian minimum when buying a new home) and save the rest for closing costs.

4.      Because Jane is only putting down 5% she has no choice but to take out CMHC Insurance which protects the bank in case the mortgage goes in to defaults and will cost her over $9,000.

5.      During talks with her lawyer she decides it is necessary to obtain title insurance to protect her investment against title fraud, unknown liens or encroachments.

If the buyer can’t pay the lender is protected, if the house has issues with the title or liens it falls on the buyer and if they want to get out of the mortgage for a better rate the buyer faces lavish buyout fees. If you ask me it the bank is pretty safe.

Side Note – in the example above the interest collected by the bank after 3 years of the 5 year term would be $47,133.14. The principal paid would only be $11,920.90. I’d say it seems pretty excessive to charge someone a penalty after that kind of a return.

Around the world countries seem to feel the same way. On March 23, 2011 Australia banned the so called “Exit Fees”. Australian regulators found that such fees are so unfair that they have to be banned made them illegal. Here is what International Business Times reports.

Australian Treasurer Wayne Swan spoke of how this law was a victory for Australian families “This is an important day for consumers because one of the biggest roadblocks stopping Australians getting a better deal for their families will finally be removed,” he said…“This critical measure will help boost competition in the home loan market over time, by giving consumers greater freedom to walk down the road if their bank isn’t doing the right thing by them.”

“Exit fees” in Australia are the equivalent of our pre-payment penalty fees. Here is the explanation of “exit fees”:

Exit fees, or early redemption penalties, are fees that are charged to a home owner when they are finishing their loan at an earlier stage of the loan than agreed… Exit fees are often a hidden cost when changing mortgages. A mortgage can look to be a lot cheaper, but the exit fees from the old mortgage will often mean that the cost is quite a bit higher than it appeared at first.

As of June 1, 2011 exit fees are banned in Australia. Canadians on the other hand will continue to pay thousands of dollars if they decide to try and get a head.

Another Example of how the tide may be changing is SBI (State Bank of India). On April 23, 2011 SBI announced that they will no longer be charging a penalty to break a mortgage. You may ask, “is this true, a bank making the decision to not charge a fee just to be fair?” Well that what happened! To read more go to the Hindu Business Line.

So what is a person like you a me to do? Maybe nothing, but if you think like me that isn’t good enough. I suggest we all write our local MP and demand they address this issue publicly. Canada is known for our strong standards on how we govern our banking industry. Maybe it’s time we not only protect the bank but also the people who use them.  After all, the Government is supposed to protect the average Canadian, and in the end it would do just that.