This blog sets out the issues underlying the mortgage penalties triggered by mortgage prepayments in Canada. It also aims to seek feedback and gather testimonials from citizens and real estate and mortgage professionals in order to propose to the legislature the elements of enhanced mortgage lender monitoring.
Your comments are very important. If you have examples of what you feel are exorbitant mortgage penalties, please e-mail them to: info@penal-t.com
According to the Canadian Association of Accredited Mortgage Consultants, there are 9.3 million homeowners in Canada, of whom 60% have mortgages with outstanding principals totalling $770 billion. Sixty-five percent of these loans are fixed-rate mortgages and 70% have a term of five years or more. About one-quarter (24%) of homeowners had some form of mortgage financing activity during the past 12 months.
It's a mortgage lenders' market, as the volume of mortgage financing creates significant sources of income, particularly from mortgage penalties triggered by the prepayment of fixed-rate mortgage loans.
Mortgage penalties in Canada are the subject of substantial criticism. They are deemed too high, unfair and inconsistent, among other things. The calculation of mortgage penalties in Canada lacks monitoring and consistency, while the penalties themselves are perceived as unfair.
Financial institutions charge a mortgage penalty to borrowers who prepay their fixed-term or fixed-rate mortgage in order to cover closing costs and the effects that mortgage rate fluctuations have on future cash flows. The mortgage penalty on variable-rate products covers closing costs without regard to rate fluctuations, but should never exceed the financial loss generated by the prepayment of a mortgage plus the usual closing costs.
Mortgage lenders are currently able to charge a penalty that is generally the greater of three months' interest or the Interest Rate Differential (the difference between the existing mortgage rate and the one at which the borrower would be renewing). But because of the confusion surrounding definitions and calculation methods, penalties are usually much greater than the financial value of the real rate fluctuation.
The issue has become so large that it has now hit Ottawa's radar. In the March 4, 2010 federal budget, Finance Minister Jim Flaherty said that he would modify the legislation in order to standardize how prepayment penalties are calculated and disclosed.
Mortgage penalty calculations lack monitoring, which results in abuses (or penalty surcharges) by some mortgage lenders. Each lending institution offers its clients various products and has its own way of calculating the penalty. To add to the confusion, mortgage penalties are not always calculated as stipulated in the original mortgage contract when a mortgage is renewed.
Mortgage penalty irritants must be eliminated if liquidity in the Canadian real estate market is to be improved. Improving that liquidity is a key strategic objective of the real estate profession. All necessary measures must be put in place to do away with such irritants and facilitate the sale and purchase of properties in Canada. Penalty surcharges are seriously hampering real estate transactions.
There are no mortgage penalties for most mortgage loans in the United States. That does NOT, however, explain the mortgage difficulties recently experienced in the U.S.: mortgage penalties are totally unrelated to sub-prime mortgages.
In Canada, mortgage penalties are a major transaction cost and restrict market liquidity. They are often equal to several times the real property transfer tax and are charged to the seller, which often unduly delays the marketing of a home for such reasons as divorce, the birth of a child, death, relocation, etc. It is not at all in the public interest to support such a curb on real estate market liquidity.
Mortgage lenders use various tools to manage interest rate risks, including options, futures contracts and interest rate futures, in order to cover risks and ensure greater financial performance stability. In some cases, lenders are able to anticipate interest rate movements and benefit from them. Such tools are generally not available to private individuals.
Although five-year closed fixed-rate mortgages are the greatest cause for concern, monitoring should be introduced for all fixed-rate products and limits should also be implemented for variable-rate mortgage loans.
Canadian mortgage lenders like the status quo, especially in a context where interest rates are going to increase, as prepayment penalties will magically disappear and be replaced with substantial hidden gains that are recognized when mortgages are prepaid. There's a lot of money at stake.
The numerous grey zones in the definition of the rates to be used, combined with a lack of clear rules, means that borrowers are often billed DOUBLE, TRIPLE or QUADRUPLE the lender's loss arising from prepayment. Furthermore, the penalty calculation is one-sided and always to mortgage lenders' advantage whether interest rates are falling or rising.
Aggrieved borrowers currently have no choice but to turn to the Ombudsman for Banking Services and Investments (OBSI). The OBSI is an independent organization that resolves disputes between participating banking services and investment firms and their customers, provided they are able to reach an amicable settlement. Complaints heard by the OBSI often deal with mortgage prepayment penalties. The limit for OBSI compensation recommendations is $350,000.
The status quo is unacceptable for borrowers. Legislation is urgently required to eliminate and prevent the abuse of Canadian borrowers by Canadian mortgage lenders.
This blog sets out the issues underlying the mortgage penalties triggered by mortgage prepayments. It also aims to seek feedback and gather testimonials.
Your comments are very important. If you have examples of what you feel are exorbitant mortgage penalties, please e-mail them to: info@penal-t.com
Sincerely,
Richard Beaumier, MBA, FCA, CFA
Chartered Real Estate Broker
Related Articles
Federal Budget Highlights - March 2010
Calculating Mortgage Penalties in Canada
http://www.fcac.gc.ca/eng/publications/mortgages/penaltycharges-eng.asp
http://mortgagehelp.ca/penalties.htm
http://www.hotfrog.ca/Companies/Invis-Lisa-Alentejano/Calculating-your-mortgage-penalty-Canada-9323
http://www.canadianmortgagetrends.com/canadian_mortgage_trends/interest-rate-differential-ird.html
http://hubpages.com/hub/HowToCalculateMortgagePenalty
http://www.calculatorz.com/united/earlyrenew.cgi
Blogs and Articles on Mortgage Penalties
http://www.ellenroseman.com/?p=347
http://www.thestar.com/comment/columnists/article/600049
http://mortgageratemontreal.com/mortgage-penalties/penalties-assessed-due-to-mortgage-contract-cancellation-are-they-valid-or-ulta-vires/
Class Action Lawsuits
http://www.option-consommateurs.org/en/lawyers/recours_collectifs/28/
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