There’s never been a better time to own a home. Homeowners are enjoying record low mortgage rates. It’s not that hard to find a mortgage rate below 3 percent on a 5-year mortgage. While low mortgage rates are good news if you’re looking to pay down your mortgage sooner, if you need to break your mortgage early it’s another story (at least if your mortgage is with your traditional big bank). Mortgage penalties and in particular bank mortgage penalties have perhaps never been more painful (or more difficult to understand).
If you have a mortgage with one of the big six banks, you better watch out. Historically low mortgage rates are leading to record high mortgage penalties. Don’t think it can happen to you? Think again. The big banks are notorious for hitting homeowners with sky-high mortgage penalties like a ton of bricks. They won’t show any mercy when it comes to paying mortgage penalties, not even for injured soldiers.
You’re probably wondering why the big banks still have their inflated posted rates. It can’t possibly be good for business. Imagine if supermarkets sent you circulars with their full prices listed. If you wanted their sale price, you’d have to negotiate with the cashier. That’s no way to do business, yet that’s the way the big banks operate. As of today (September 20, 2015), CIBC has a 5-year fixed rate mortgage at 4.79 percent. No one in their right mind would take the posted, yet it’s still remains.
It’s no coincidence the big banks have those inflated posted rates. You might be wondering why the big banks don’t just do away with their outrageous posted rates. The reason is simple: mortgage penalties. If you have a variable rate mortgage, the mortgage penalty is pretty straightforward: three months’ interest. But if you have a fixed rate mortgage, it gets a bit more complicated. The mortgage penalty on a fixed rate mortgage is the GREATER OF three months’ interest or the Interest Rate Differential (or IRD for short). I think the big banks should change the IRD to the DTR, short for dead to rights. The IRD is how the big banks can have you over a barrel.
I know what you’re thinking. Why do I care about mortgage penalties? I don’t plan to break my mortgage, so mortgage penalties don’t matter. Unfortunately, life has a way of throwing you curveballs. Whether you lose your job, get sick or divorced, accidentally conceive triplets in your 40’s, or simply decide to stop working and travel the world – the big banks call the shots. Here’s a fact that may change your mind: statistically speaking, less than 20 percent of 5-year fixed mortgage clients have actually taken their mortgage terms to maturity in the last 5 years. Even in normal interest rate periods the percentage of people who break before the term is up is as high as 50 percent.
The big banks march to the beat of their own drum when it comes to mortgage penalties. While wholesale lenders base the IRD off of their discounted rate, the big banks use their inflated posted rate (that no one in reality ever pays) and discount rates off shorter term loans (that no one ever gets) – to arrive at penalty amounts everyone knows is unfair. If you’re locked into a fixed rate mortgage at a higher rate, you may be thinking of breaking your mortgage until you find out what you mortgage penalty would be. The greater the difference between current mortgage rates and the posted at when you signed up for your mortgage, the higher your mortgage penalty. It’s not unheard of for homeowners to face mortgage penalties of $30,000 or higher (That’s right, folks, your mortgage penalty could be as much as a brand-new shiny car! I don’t know about you, but I’d rather have a new car instead!). One client of mine got quoted a penalty of over $150,000 (albeit it was an over $2 million dollar mortgage).
So how do you protect yourself from the underhand tactics of the big banks? Here is the must-ask question when negotiating a fixed-rate mortgage: do you use discounted or posted rates to calculate penalties This is important because using posted rates can result in a much higher penalty. For some real world numbers, you can use the mortgage prepayment calculators all lenders now provide on their websites. They show penalties for paying all or a portion of your remaining mortgage balance (to find a lender, Google your lender’s name and “mortgage prepayment calculator”). For your convenience, I’ve included links to the mortgage prepayment calculators of all the big banks:
Royal Bank of Canada (RBC)
TD Canada Trust
National Bank of Canada
Bank of Montreal
CIBC
Scotiabank
Here’s a real world example to show you can costly mortgage penalties can be. 3 years ago, I set up a $250,000 5-year mortgage and has a balance owning of $200,000. Assuming an original mortgage rate of 3.64 per cent with a discount of 1.5 percentage points, the mortgage prepayment calculators at several big banks showed penalties ranging from $5,000 to $7,600 approximately. If that doesn’t make your hair stand on end, I don’t know what will!
The lesson is to get all your facts straight before signing up for a mortgage especially when terms and conditions are becoming more important than the interest rate. Its the total cost ownership and how the mortgage compliments your personal financial plan that matters most in the long run. Your mortgage is most likely the largest debt in your lifetime, so it’s important to make sure it’s done right.