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Balaberde: What you should know about mortgage prepayment calculations

How many of us have ever questioned what our prepayment penalty would be should we be in a position during the term of our mortgage to want to make changes?

Depending on which financial institution your mortgage is with, the answer could be shocking.

In light of many consumers looking to switch or refinance mortgages due to record low interest rates, the Financial Consumer Agency of Canada has seen a marked increase in complaints from consumers about mortgage prepayment penalty calculations based on interest rate differentials.

The complaints received generally highlighted three issues:

• The descriptions of the components to calculate the prepayment penalty are vague and/or difficult to understand.

• Some components that are required to calculate the prepayment penalty are missing (e.g. posted rate vs. discounted rate) and/or there is no reference on how to obtain information required for the calculation if it is not known at the time of disclosure.

• There appears to be a discrepancy between the prepayment penalty formula that is disclosed to consumers and the system calculation used by some institutions (e.g. estimated IRD vs. actual IRD charge)

Financial institutions are now expected to incorporate the following

information into their mortgage prepayment

disclosure documents.

• They must disclose the manner in which the mortgage prepayment charge or penalty is actually calculated.

• There must be a clear description of all the components included in the prepayment calculation.

• The disclosure must be made in a language and presented in a manner that is clear, simple and not misleading.

• Disclosure of a complex calculation must be accompanied by a simplified method to estimate the prepayment penalty.

With this information, consumers may assess whether the mortgage prepayment is right for them in their financial situation.

What does that mean to you, the consumer?  Most financial institutions now have a prepayment calculator on their websites.  In addition, if you are shopping for a mortgage there should definitely be questions you should ask.

Here is an example of two  different financial institutions calculating a prepayment penalty.

A bank or credit union verses an exclusive mortgage lending institution for a mortgage amount     200,000 for a five-year fixed term mortgage at 3.09 per cent. The bank’s posted rate when you took the mortgage out  was 5.24 per cent so your interest rate differential (difference between your rate and posted rate) is 2.15 per cent.

Let’s say, as an example, you are two years into your mortgage and you have perhaps sold your home and are paying the mortgage off.  Or maybe you would like to move the mortgage to another lending institution for a better rate.

Your IRD penalty on the preceding example would be a whopping $7,882.29.

Now let’s say your mortgage was with one of the many exclusive mortgage lenders available who do not work with a posted rate—and there are plenty of these financial institutions out there accessible only through a mortgage broker.  The interest differential would be zero because the mortgage rate you have is the only rate it offers.  Your prepayment penalty would be a mere $1,460.21.

The ability to explore all the facts and options available to you the consumer with a professional mortgage consultant is to your advantage and along with all the knowledgeable information you will receive .

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