One of the most common issues with refinancing a home is the interest rate penalty that comes with ending a mortgage term before maturity. Due to the sometimes complex calculations the banks use to determine this amount – consumers have been left in the dark when trying to make a decision on whether the cost of refinancing early is worth it or not. Recent changes and more to come will regulate the banks to provide more information up front and over the life of your mortgage on penalty costs. As a broker I always discuss this with my clients to ensure we work with lenders that have best options for penalties if ending the term is a possibility for any reason.
Courtesy of the Globe and Mail:
Historically, lenders have used cryptic penalty language that disguises just how expensive. As a result, folks trying to break their mortgage are routinely shocked and disappointed by four- or five-figure penalty quotes.
Interest rate differential (IRD) charges, commonly called “penalties,” have long been the biggest culprit. IRD charges compensate a lender for lost interest when you prepay large portions of a closed mortgage early. They’re basically the difference between the interest you promised to pay and what the lender can earn today on a mortgage of your size. Without a computer, even most lender reps cannot calculate IRD penalties with precision.
The biggest penalty I ever saw was $99,000 on a multimillion-dollar property. The average is far less than that – in the four-digit range – but for a homeowner with little discretionary income, it might as well be $99,000.
But things are changing for the better. As of this month, the Department of Finance has convinced banks to peel back a layer of opacity. Most banks now agree to a “voluntary” Code of Conduct that requires them to post plain-English explanations of prepayment charge calculations and provide website calculators so people can run their own penalty estimates.
That latter development is a colossal win for mortgage consumers. Most major banks now have IRD calculators on their websites.
As helpful as these calculators are, there’s one essential piece of the puzzle that most still don’t provide: the discount you received at the time you got your mortgage.
This discount is key for determining your IRD penalty with the major banks. They could easily permit estimation of discounts online (using their historical posted rates), but omitting this data forces you to call in and listen to their sales pitch to retain your business before you can switch lenders.
Another problem is that few non-bank lenders have taken the initiative to create online penalty calculators. That makes comparing penalties between banks and non-bank lenders unnecessarily difficult, which incidentally plays right into the big banks’ hands.
The majority of long-term fixed-rate mortgage holders terminate or change their mortgage before their term is up. In fact, the average five-year mortgage lasts only three to four years. Penalties apply in only a minority of these cases, but for those who are affected, they can substantially raise your overall borrowing costs
It therefore pays to guesstimate mortgage breakage costs in advance and avoid surprises later. In doing so, you’ll often find that a lender’s bargain interest rate is offset by its harsh penalty.
Before settling on a lender, try this. If you want a five-year fixed term, have your mortgage adviser estimate that lender’s penalty as if you planned to break the mortgage after 3.5 years (the average breakage), assuming rates stay the same. Then ask the adviser to give you a sense for how this penalty would compare to the “typical” lender.
Penalties are a realm where borrowers need knowledgeable advice. Sadly, many advisers are inexperienced with penalty calculations and give you a blank stare when you ask too many questions. (That’s a good clue that you should deal with someone else.)
Fortunately, the Financial Consumer Agency of Canada is doing a noble job encouraging clarity with mortgage penalties. By March 5 of next year, it will go a step further by requiring banks to provide: annual information to help consumers calculate their penalty, written penalty statements upon request with clear calculation explanations, and access to exact prepayment penalty quotes by phone.
To view ten questions visit http://www.theglobeandmail.com/globe-investor/personal-finance/mortgages/ten-questions-to-help-you-avoid-mortgage-penalty-shock/article4545693/