Mortgage Articles
Mortgage Discharge Penalties
by Heather Paterson
The Mortgage Coach
This is the most difficult topic related to mortgages and it will continue to
be confusing until the laws in Canada are changed to require consistency on how
lending institutions charge their penalties.
Most lenders charge an early payoff penalty on closed mortgages if the debt is
paid prior to the maturity of the term. The lending institution must describe
the penalty they could charge on the mortgage document.
The most common penalty is: the greater of three months interest penalty OR
the interest rate differential.
In other words, whichever amount is the larger of these two figures will be the
penalty.
Other kinds of penalties are listed below.
Three Months Interest Penalty
If you are paying off the mortgage before the maturity date, most lending institutions
charge three months interest penalty (or an interest differential penalty).
The present mortgage balance is multiplied by the current interest rate and multiplied
by three.
Interest Rate Differential/Loss of Interest
This usually means the difference between the interest rate on the mortgage contract
compared to the rate at which the lending institution can re-lend the money. For
example:
If the mortgage has a balance of $125,000 at 9.25%, and there is 2 years left
to go and the current 2 year mortgage rate is 6.25%. Then the lending institution
will probably charge -
$125,000 X 24 months X 3% (9.25 - 6.25) = $7,266.21
However, just to further confuse the issue, the penalty above has not been present
valued. This is when a lender charges a lower penalty because you are paying all
of the 'extra' interest (in the example 3%) now, not over the remaining term.
Some lenders use present value, other lenders do not.
Other Kinds of Penalty
Methods of calculating penalties are as varied as the lenders' imaginations!
The following outline describes some penalties charged by lenders.
Some examples:-
Greater of three months interest penalty OR the interest rate differential.
CMHC mortgages registered prior to July 1999 - during the first three years,
the penalty is the greater of 3 months interest OR interest rate differential.
After three years of payments made on a 4 or 5 year term (or longer) the penalty
is three months interest.
CMHC mortgages registered after July 1999 - CMHC mortgages will now have the
same penalty clause as the institution lending you the mortgage funds.
Some examples of different payouts:
1. Two months penalty interest (based on the floating rate in effect at the time
of payout) calculated on the outstanding balance during the first three years
of the term and no penalty charged at all for the remaining years of the term.
2. The mortgage cannot be paid out unless there is an arm's length sale - then
the penalty is 3% of the outstanding mortgage balance.
3. The mortgage can not be paid out unless there is an arm's length sale - then
the penalty is the greater of three months interest OR 3% of the outstanding
balance.
4. Same as above, but not more than three months interest in years 4 and 5 of
a five year term.
5. For non-arm's length sales - it is the greater of three months interest OR
interest rate differential to the bond rate for the remaining term.
6. For arm's length sales - it is the greater of three months interest OR interest
rate differential to the current posted mortgage rate for remaining term.
Clear As Mud? Here Are Some More Issues!
Do not assume the same lender charges penalties the same way for each type of
mortgage. Examples 1, 4 & 5 above are all charged by the same lender on different
products.
Do not assume the penalty charges you agreed to with the original mortgage document
are the same when you renew with the same lender. Their policies concerning penalty
charges are always changing.
Do not assume the same wording means the same calculation with different lenders.
For example the term 'interest rate differential' means very different penalty
policies with different lenders. The terminology is not used consistently.
There have recently been class action law suits against at least two Canadian
lending institutions over their practices regarding the calculation of penalty
charges. The law is still evolving regarding acceptable practices for calculating
penalties.
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