If you have an existing closed mortgage and you want to break your mortgage contract you will most likely have to pay a penalty. When you signed your mortgage documents you agreed to the terms and conditions of the mortgage until the term is complete. Of course the lender wants to recoup some of their lost interest if they let you out of the deal. Fair enough.
How Mortgage Penalties Have Changed
In the past, the standard payout penalty was three months interest. However, back in 1999 CMHC removed that clause from their mortgages and lenders can now opt to use the Interest Rate Differential method instead. Unfortunately, there are no regulations in place to restrict how the IRD is calculated or laws to protect consumers. On top of that, IRD calculation is often not transparent or easy to understand.
If you are lucky enough to have a CMHC mortgage with a three month interest clause in your mortgage agreement it is pretty easy to get a rough idea of the penalty. However, most IRDs aren’t much trickier if the lender deals fairly. The IRD is usually the difference between what you have left on your mortgage and what the rate they lend out now. For example, if you have 2 years left on a 5 year mortgage, the IRD would be the difference between the lender’s current posted 2-year rate and your original rate. This number would then be multiplied by your mortgage balance. The grey comes into play when it comes to what the lender’s “posted rate” is. Some use discounted rates which makes the spread between your rate and theirs larger. Others calculate the penalty to the next term end date and not the past one. Yet others make the calculations so complex they hope no one will ever question them.
Understand The Fine Print Before You Sign
Naturally, the best way to protect yourself is to know what you’re signing before you sign. Take your mortgage documents to your lawyer and have them check for obscure clauses. So, you will know exactly how your penalty is calculated should the time come when you want to get out of the contract. Some mortgages do not allow you to break the contract at all. In that case your mortgage is locked in until the end of the term.
If you are able to get out of your contract, never depend on the figures the lender gives you. Work it out for yourself and if they don’t jive, find out why. There are online IRD calculators you can use that will give you a good idea of what the penalty “should” be with a reputable lender or you can contact a mortgage professional to review your contract.
Check For Pre-Payment Clauses
If your penalty is huge, be sure to check if there is a prepayment clause in your contract. Prepayment clauses often allow up to 20 percent of the balance paid in a lump sum payment without a penalty. If you have money somewhere else that you can pull out it might be worth it to bring your balance down and then pay the penalty to save you money. Even if you borrow, the interest costs on the temporarily borrowed funds will likely be much less than the savings on the penalty. Prepayments follow the calendar year too, so if you time things right you can squeeze in two prepayments!
If you are still in a pickle, try complaining up the corporate ladder. Even if you get a reduction in the amount it is worth the time. If you still feel you are being ripped off, try the Ombudsman for Banking Services and Investments. This organization works for FREE for consumers, and they help mediate complaints.
You can also spread the word about the lender if worst comes to worst. No one likes bad press and the squeaky wheel often does get the grease. At the very least, it will put pressure on our government to legislate regulations to govern IRDs in the future so no one is the same uncomfortable situation.
Have questions about how to reduce mortgage penalties and your options when it comes to getting a better mortgage rate?
Call Mortgages.ca today at 877-245-1185 for a free evaluation of your mortgage agreement.