I cannot stress enough the importance of understanding your lender’s mortgage prepayment penalty before you sign on the dotted line. Unless you are able to take your mortgage to your next property, breaking your mortgage mid-term can reap havoc on your finances with unforeseen expenses.
A couple walked into my office this week excited about a new home they had made an offer to purchase. They needed a larger mortgage, but their existing mortgage lender had declined their request to increase their loan amount. Had this lender approved them, they could have increased their mortgage amount and perhaps avoided serious penalties.
The good news is I was able to get them approved for a five year closed mortgage at 2.89%, with only a 15% down payment. They lifted their condition of financing and it’s full steam ahead. The problem arose when they asked their existing mortgage lender, a major chartered bank, to calculate their payout penalty when they sell their current home.
Their mortgage balance is around $346,000 and it has a 2.99% interest rate, with just over four years remaining. They were shocked to learn the penalty and discharge fees would be close to $12,000. How can this be, they cried?
You might think that my clients should not have to pay a great penalty – after all they only contracted to pay 2.99% and that is in fact the rate many banks are now offering on four year mortgages.
BUT, this bank says the couple actually received a 2.15% discount from the posted rate, and therefore the bank is entitled to earn 2.15% more on their money when they allow them to prepay their mortgage.
As a result, instead of incurring a reasonable penalty of $2,586, the bank is now demanding $11,595.
Related article: You should understand mortgage prepayment penalties
Please understand mortgage selection is not all about the rate. Personally, if need be, I’d rather pay a slightly higher interest rate to a lender with a consumer friendly prepayment penalty policy, than make myself hostage to a lender whose policy borders on usurious. We mortgage agents have access to lenders with reasonable prepayment terms.
Take a look at where you think you want to live for the next several years. It may make sense to select a shorter term than the ‘norm’ of five years, to ensure your mortgage matures around the time you will be ready to move. That said, if you like long term rates as they are, you might choose a longer term still, provided your mortgage lender is known to be flexible and reasonable.
Many decent lenders will automatically reduce your penalty by 15% to 20%, by ‘pretending’ you had made a legitimate one time prepayment just prior to breaking your mortgage. So even if you don’t have the money for this prepayment, ask what your lender will do for you.
IRD penalties usually do not apply to closed variable rate mortgages; they just calculate 3 months simple interest. Also note a few lenders don’t allow you to break a mortgage early—regardless of the penalty—unless you are selling your property.
As Rob McLister of Canadian Mortgage Trends advises…….
“The moral: Always contact your lender directly for an exact penalty quote.”
A useful tip for RRSP contributions – put money in when your personal tax rate is high, and if you withdraw money, do so when your tax rate is low.