Canadians like to pay down their debt, including mortgage debt. The faster you can pay off your house, the faster you are mortgage-free and in a better position to upgrade your home or retire. But did you know you can face significant penalties for prepaying your mortgage? Prepayment or payout penalties can be baffling, even to financial professionals.
The Financial Consumer Agency of Canada recently rolled out an initiative that requires financial institutions to be more forthcoming about how these penalties are calculated and when they are administered, but in the end it is up to you as the consumer to find out what kind of prepayment will - and won't - constitute a penalty.
What Is a Mortgage Payout Penalty
A mortgage payout penalty is a punitive charge levied by financial institutions against fixed-rate mortgage holders that want to pay off a significant amount early. They vary widely between financial institutions, ranging from a few months worth of interest to penalties based on interest rate differentials (IRD). In simplest terms, an IRD is the difference between what the lender could have charged you at today’s interest rates and the interest rates you received when you locked in your mortgage. The amount of the prepayment is also a factor. The typical prepayment penalty starts at thousands of dollars and can even run over ten thousand dollars. They aren’t cheap.
Why do Mortgage Payout Penalties Exist?
You would think that the bank would be interested in getting its money back as quickly as possible. But you would also be wrong. Banks don't make money on short-term loans. They make their money on the interest payments on those loans and the longer you take to pay them back, the more interest they rake in. A mortgage payout penalty is the bank's way of ensuring that it makes a profit even if you win the lottery and can pay off your house years before your expected mortgage retirement date.
Strategies to Minimize Payout Penalties
Even fixed-rate mortgages can come with prepayment privileges which allow you to pay down a specific amount. The dates that you pay and the amount that you pay are both very important. Rather than doing the calculation yourself, contact your bank and double-check your figures with a customer service representative to ensure you aren’t paying over and above what your prepayment privileges allow. Failure to follow the exacting rules on prepayment could trigger a payout penalty.
Negotiating a portable mortgage can also help you avoid payout penalties. This way, if you find yourself needing to suddenly move due to a job change or other circumstances, you don’t face a penalty when you close the sale of your old home.
Why You Should Care About Payout Penalties
Payout penalties aren’t just a concern for those with a sizable amount of disposable income. What if you get an inheritance from a relative that you want to use to pay down your mortgage, or a bonus from work? Larger-than-expected tax returns, hiring bonuses, and similar influxes of cash are more common than you may think, and one of the smartest things you can do with them is to pay down your mortgage. As mentioned above, you may also need to move, and this can even incur a prepayment penalty.
What Kind of Mortgage do You Have?
The first factor in determining if you are going to have payout penalties is if you have a fixed- rate or variable rate on your mortgage. While a fixed-rate mortgage gives you a significant financial advantage in terms of locking in a low interest rate, it usually comes with payout penalties. Even so, a fixed-rate mortgage is currently the best option for most homeowners with consistently low Canadian interest rates. A variable rate mortgage will often carry smaller pre-payment penalties than a fixed-rate mortgage, but carries more risk in a low-rate environment due to the risk of rising rates in the future.
Mortgage Payout Penalty Calculators
As part of the Financial Consumer Agency of Canada initiative, all banks must post payout penalty calculators on their website. You can find most of the major ones here. You should also be able to contact your bank’s customer service line and have a payout penalty calculated for you by a bank representative. It is wise to do both to make sure that you aren’t missing out on any key information you need to calculate your penalty.
How First Foundation Can Help
When you are dealing with a mortgage broker, you are dealing with a firm that can find you a mortgage that fits your specific needs. A mortgage from First Foundation tailored to what you want, including lower payout penalties if that is a priority for you. First Foundation can advise you on payout penalties with various lenders. If you choose to refinance your mortgage with us, we will tell you exactly what the payout penalties are and can be easily reached on the phone or by email if you have any questions at all about your mortgage. We don’t stop being your agent after we secure your mortgage for you, and we’ll often know faster ways to get the information you want if you make us your first point of contact.
Waiting for Your Mortgage Renewal Date
Banks rely on most consumers sticking with what they know on their mortgage renewal date. While they don’t usually choose this time to hit you with a huge increase, they certainly don’t offer you any deals. If you have done the research and are subject to significant payout penalties with your current mortgage, you may have to wait for your mortgage renewal date to find a better deal with another institution. First Foundation is one of Canadian Mortgage Professional’s Top 50 Mortgage Brokers and we can usually offer a far better rate or terms than your bank does.
Give us a call in advance of your mortgage renewal date to see what we can do for you.