Why Canada Fixed Rate Mortgage Penalties Border on Fraud On May 21, 2014 in Mortgage Players compliments of Calum Ross How many big lender fixed rate mortgage pre-payment (IRD) charges rob consumers
According to Criminal Code of Canada: “380.(1) Every one who, by deceit, falsehood or other fraudulent means, whether or not it is a false pretense within the meaning of this Act, defrauds the public or any person, whether ascertained or not, of any property, money or valuable security or any service,” (a) is guilty of an indictable offence”
Now when I read the above statement and see an everyday client compensating a financial institution that makes over $1 billion dollars a quarter, I have a hard time with my client paying apenalty of over $5,245 for a mortgage of less than $180,000 with less than two years remaining on their current mortgage term (see more below)
Section 380.1 of the Criminal Code then goes oBank Robbing Customern to say:
380.1 (1) Without limiting the generality of section 718.2, where a court imposes a sentence for an offence referred to in section 380, 382, 382.1 or 400, it shall consider the following as aggravating circumstances:
(a) the magnitude, complexity, duration or degree of planning of the fraud committed was significant;
(b) the offence adversely affected, or had the potential to adversely affect, the stability of the Canadian economy or financial system or any financial market in Canada or investor confidence in such a financial market;
(c) the offence involved a large number of victims; (c.1) the offence had a significant impact on the victims given their personal circumstances including their age, health and financial situation;
(d) in committing the offence, the offender took advantage of the high regard in which the offender was held in the community;
(e) the offender did not comply with a licensing requirement, or professional standard, that is normally applicable to the activity or conduct that forms the subject-matter of the offence; and
(f) the offender concealed or destroyed records related to the fraud or to the disbursement of the proceeds of the fraud.
I have to say that reading 380.1 subsections (b), (c) , and (d) make me even more uncomfortable with the concept of abuse of power and bring into question purposeful misrepresentation.
Before you spend too much time agreeing or disagreeing with this quick introduction to the criminal code and what it says about fraud please realize that I hold an MBA in Finance and despite a reasonably impressive LSAT score – I did not got to law school nor can I formally make claim to or support a full legal opinion on this matter or any other legal matter from the criminal code so don’t rely on my above statement as any form of legal opinion…
However, you’d not have to be a trained trial lawyer to look at the above definitions and take a pause to think: “Hmmmmm, that’s what my bank just did to me.” Well if you are one of the hundreds of thousands of Canadians who refinanced a fixed mortgage rate with one of Canada’s big banks you may want to read on, that should be your response. Fixed Rate Mortgage Penalties: How the Big Banks Have You Hook, Line and Sinker
For most homeowners, figuring out your mortgage penalty can be like solving a Rubik’s Cube. Mortgage penalties seem to be written in a language similar to legalese. The sad fact is that you don’t realize how costly it can be to break your mortgage until you have to, are forced to, or if you decide to refinance or sell your property. Life happens, changes occur, but your financial penalty can be quite overwhelming when it does. That is why if you are considering a fixed mortgage with a big bank today, , you had better pay close attention to the posted rate (not the discount rate you are getting) , as it can come back to bite you in the backside if you break your mortgage down the line.
What the Banks Aren’t Telling You About the Posted Rate
They say only a fool pays the posted rate. Accepting a bank’s posted rate is like going into a car dealership and offering to pay the sticker price. You may be wondering why the big banks still keep their inflated posted rates. It can’t be good for business, can it? What if a supermarket sent out a flyer advertising 4-litre bags of milk for $6.99, when you could buy milk down the street for $3.99? We’re willing to bet you’d flock down the street
The reason appears to be because of fixed rate mortgage penalties. Although wholesale lenders (lenders that start by giving you a discounted rate such as ING, First National, Street Capital, and CMLS )do offer better rates than the big banks and come with less costly mortgage penalties, a lot of clients feel more comfortable dealing with their local bank branch (even if it ends up costing them a bundle for this seemingly misplaced trust).
The big banks are “banking” on the relationship and perceived comfort they’ve built up with you over the years. Your bank may be willing to match a lower mortgage rate; you’ll just have to do the legwork. However, it is not only the interest rates you had better be paying attention to. It is also the terms of that mortgage and this is where you can really get caught and in fact agree to paying a hefty mortgage penalty in the future without really knowing it.
Many risk averse homeowners choose fixed mortgages at the big banks over variable without realizing the trap they’ve gotten themselves into. Although you’re protecting yourself from interest rate risk, you’re leaving yourself open to hefty (aka thousands of after tax dollars – hefty) mortgage penalties. Solving the Mysterious Interest Rate Differential IRD Puzzle
For those with a fixed rate mortgage, the IRD – short for interest rate differential – can be like a curse word. Mortgage penalties are pretty straightforward if you have a variable-rate mortgage – expect to pay the equivalent of three months’ interest. With a fixed-rate mortgage it’s a whole new ball game. If you’d like to break the shackles of your fixed-rate mortgage, you’ll pay the greater of three months’ interest or the IRD. I should note that I have two finance degrees and I have personally arranged over $1.7 billion of mortgages and even then these calculations seem complex and inconsistent to me. Beware the IRD
The IRD is how the big banks make out like bandits at your expense. In principle, the IRD is supposed to compensate a lender for the lost interest when you break your mortgage, but in reality the big banks are using it as a massive profit center. In layman’s terms, the IRD is the difference between what the big banks can loan out money today on the streets and what they could have earned had you stayed with them until renewal. While secondary lenders often use their discounted rate as the comparison rate, the big banks use their bloated posted rates, which can result in hefty mortgage penalties.
Besides padding the bottom line of the big banks, they also use these penalties to make it prohibitive to switch lenders. Costly mortgage penalties are like a noose around your neck; due to the prohibitive cost, they may keep you with your lender, even though you’d like to refinance or upsize your home. Although some people hold their nose and pay the costly mortgage penalty, I’m willing to bet you wouldn’t have signed up for a mortgage with the big banks if you knew how costly it would be to break your mortgage. The Mortgage Mismatch
Whether it’s the allure of a lower mortgage rate, to refinance, or buy that McMansion down the street, a lot of homeowners choose to break their mortgage. Most homeowners aren’t thinking about breaking their mortgage when signing on the dotted line, but they should be. There is a mortgage mismatch in the market: 5-year fixed rate mortgages are pushed by the lenders, yet the average first-time homebuyer only remains in their home for between 3 and 4 years on average.
Although an increasing number of homeowners seem to be wising up to the smoke and mirrors of the big banks, there are still thousands of homeowners that find themselves unknowingly at their mercy every year. Unlike credit card issuers who are required to provide a very clear and defined information box when you applying for a credit cards, the bank’s mortgage documents aren’t regulated the same way despite the dollar figures being massively larger. It’s left up to homeowners to read and try to interpret the fine print to find out just how restricted they are and how large their penalty can be. Although all mortgage lenders must provide mortgage prepayment calculators on their website, the penalties can be misleading. You can often find yourself on the hook for thousands more than you anticipated. You Can Win By Choosing Wisely
Mortgage Penalties: The Big Banks vs. Secondary Lenders
To show how costly mortgage penalties can be, let’s run through an example. Let’s say you signed up for a 5-year fixed rate mortgage at 3.49 per cent three years ago (you have two years left). You have an outstanding mortgage balance of $300,000; your monthly mortgage payment is $1,496 and your mortgage is amortized over 25 years. Let’s say the inflated posted rate that was in place when you initially signed up for your mortgage was 5.49 (you received a 2 per cent discount). If we run these mortgage “what-if” scenarios through the mortgage prepayment calculators for one of the big banks, RBC, and a secondary lender, First National, we get two very different results.
While First National comes out with a mortgage penalty of $4,067.81, RBC comes out with a mortgage penalty over triple that amount – to the tune of $14,559.19. This is for the same mortgage amounts.
The math gets even worse when you dig deeper. Here’s the kicker – what the big banks are doing is downright wrong, some have even used the words “bordering on fraud.” . In a recent case of one of my clients we discovered that RBC is using a “comparison rate” that doesn’t actually exist in the market and by doing so demanded that my client pay a penalty of over $5,245 for a mortgage of less than $180,000 with less than two year remaining. The ‘comaprison rate’ they used? 1.39% is what they said they would be able to re-lend the money out at
Well, I have been one of the top mortgage professionals in the country for over ten years and let me make this easy for you… two year money at 1.39% fixed rate does not exist! The rate RBC using is a fictional rate that only exists in their interest rate penalty calculation land. Here is the actual statement: Exhibit A: Sample RBC Mortgage Here’s a closer look at the wording each lender provided on how each lender determines the IRD:
RBC “The interest rate differential is the difference between the interest rate and our posted rate on the prepayment date for a mortgage with a term similar to the time remaining in the term and having the same prepayment options as the mortgage less your rate reduction.” Great verbiage but rate reductions are much higher on longer term mortgages and therefore much less relevant for mortgages of a shorter term. First National
“An Interest Rate Differential (IRD) is the difference between your current mortgage interest rate and the rate we can now receive for a replacement mortgage for the remaining time of the loan. It’s the slight difference in wording to the untrained eye that can triple or quadruple your mortgage penalty. The Final Thoughts – Never Leave Yourself Unprotected
Instead of negotiating a lower monthly fee on your chequing account, you should be asking your lender whether the discounted or posted rate is used when calculating mortgage penalties. If you hear the latter, you should seriously consider running the other way. After all – $5,000 in mortgage penalties pays for an awful lot of banking fees. I have found that, without having the awareness of the larger financial options, consumers will go out of their way to reduce their monthly banking fees, but will spend no time digging deeper into their mortgage terms. A classic case of stepping over dollars to get to dimes.
Unless you’re 100% certain you’re not going to break your mortgage any time soon, and you insist on having a fixed rate mortgage, you should avoid the big banks mortgages like the plague When life happens and you need or want to break your mortgage early, you’ll be at their mercy of fantasy math equations.. Although you may enjoy that free cup of coffee, and the free chequing account, it could end up being the most costly cup of coffee you’ve ever had, if you decide to break your mortgage. Now I can’t say what would happen to my firm if we conducted our business in the underhanded manner that these penalties have been handled – but I have a hard time believing I would have just won the “Canadian Mortgage Broker of the Year award” and quite probably would have zero repeat clients. This type of underhanded math leads to the shut-down, sanctions or tight regualtion on any other consumer service but sadly we don’t see that happening to the big banks..
If you have been a victim to this type of mortgage penalty then please share this article or put your comment below. Forever watching over the well-being of mortgage consumers – your advocate Calum Ross