One bank practice that that has long been ‘poke-your-own-eye-out’ frustrating is the lack of disclosure of the penalties that may occur when breaking a mortgage and the particular formula used to calculate them. The government has recently announced new measures that will require banks to be more transparent about penalties and to provide easy-to-access information on the subject to their customers.
Previously, many borrowers were shocked at the thousands of dollars in penalties they would sometimes be charged in order to refinance, switch their mortgage to another lender or even sell their home without porting their existing mortgage. Most everybody understands there will be a penalty, it’s the size of that penalty that was catching most borrowers off gaurd recently.
With most mortgages, the penalty to break is the greater of three months interest or the Interest Rate Differential (IRD). Three months interest is fairly straight forward but most of us are a bit fuzzy on the IRD. And why wouldn’t we be when lenders refuse to standardize the actual calculation of the penalty and all use varying methods of arriving at this particular penalty amount and rarely publish the calculation in their mortgage documents?
The new measures require all lenders to make their penalty information public and easily available on a website and must provide a designated, toll free phone number with penalty experts on the other end. In addition, they must provide a calculator on their websites that can be easily used by the bank’s clients to independalty calculate their penalties.
The new rules have not gone as far as requiring lenders to standardize their IRD calculation, so be sure to ask your broker or lender the calculation used when you are arranging your mortgage in the first place. The biggest disparity lies in the interest rates used to compare your contract rate to.
For instance – the purpose of the IRD is to essentially compensate the lender for the interest lost in breaking the mortgage contract. In order to determine how much interest would actually be lost, some lenders will compare your contract rate to their most compatitive rate that matches the remaining years left on your term. Other lenders will use their ‘posted rate’, which is the highest rate they offer. The difference between the two is usually pretty great and so then would be the difference in the penalty.
In any case, as a mortgage consumer, it’s important to understand that penalty calculations are a feature of a mortgage, just like the rate, term and pre-payment privilages. Educate yourself on this aspect of mortgage borrowing and ask plenty of quesitons until you understand how it works. With these new rules in place requiring clear and full disclosure from lenders, mortgage borrowers will be able to make increasingly educated decisions on the most appropriate mortgage product for them.
For more information on this and other changes to bank practices, check out this article from the Globe & Mail.