Mortgage Articles

by Heather Paterson

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.

The present mortgage balance is multiplied by the current interest rate and multiplied by three.

$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.

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.

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.

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.