Hey!
I’ve had this conversation twice in the past week with existing clients and wanted to update everyone on some fundamental information.
1. Mortgage penalties.
[] Why.
[] What.
2. Penalty formulas.
[] 3 month.
[] IRD.
3. How to avoid?
Mortgage Penalties:
My Mortgage is a contract that meets six elements of a legally binding agreement, which are: offer, acceptance, consideration, intention, capacity and legality.
Within this contract are clauses that outline penalties should I break my contract. I may break my contract for any number of reasons. Some common reasons to break a Mortgage contract are sale of home due to: separation/divorce, death, move up or down, lifestyle. etc.
I may break my Mortgage for finance related reasons, which are to lower my rate/payment, equity take out etc, etc.
Let’s all be reminded, banks are for profit institutions (shocking) and profit from my Mortgage.
Think about this …my Mortgage is a personal liability on my balance sheet. My Mortgage is a asset on my lender’s balance sheet. Simple, right.
My lender plans to profit from my loan repayment over a long period of time. In the Mortgage contract that I sign, the lender is scheduled to make a certain amount of money.
When I break my Mortgage contract, that lender receives the principal balance of money lent to me but they lose out on the future profit via repayment they planned to make. In lieu of that foregone profit, they charge a penalty as I exit.
Not all penalty formulas, for each kind of Mortgage product, are created equal.
Penalty Formulas:
Mortgage payout penalty formulas are not regulated by any level of government. Each lender has their own payout penalty formula – and they are not created equal.
For a closed Mortgage product, which means there is a defined term length (start/end date) in the Mortgage contract, there is a penalty. Example, closed fixed rate Mortgage. Or a closed variable rate Mortgage. There is a start and end date to the term which make the Mortgage closed.
Open Mortgage products do not have a defined end date so there is no penalty to exit these Mortgage products (lenders do offset this flexibility with higher rates).
Fixed rate Mortgage products will generally charge the greater of a three month interest penalty OR a interest rate differential penalty. All Mortgage lenders in Canada, for a fixed closed Mortgage, will charge one of these penalties when exiting.
Variable rate Mortgage products will only charge a three month interest penalty.
In the Mortgage market, there are “restricted” Mortgage products that come up with their own unique formulas for Mortgage payout penalties. Guess who benefits? The bank.
How To Avoid Penalties?
Not one client signs their Mortgage commitment with me, and plans to break their Mortgage. Just does not happen. Just like when I signed my marriage contract, I did not plan on being divorced. Plans change. That’s life.
I can avoid Mortgage penalties by paying out my Mortgage on my renewal date. On my renewal date I have fulfilled my Mortgage contract. If I pay my Mortgage back on my renewal date there is no penalty.
I can arrange a open Mortgage. An open Mortgage is a Home Equity Line of Credit (HELOC). This product is a revolving line of credit where I can repay or borrow money just like a personal line of credit. These Mortgage products come with special requirements to access, but they do exist.
Another way to limit penalty exposure is by selecting a variable rate Mortgage. These are only a three month interest penalty. The trade off is also being exposed to increasing interest rates which some people are unwilling to do.
Conclusion:
When I sign a Mortgage contract, to borrow hundreds of thousands of dollars of the banks money, I can be certain the bank is profiting. And fair enough. Business is business.
The point of this content is to remind my current clients, and help my new clients understand there are penalties when I break my Mortgage contract.
Various Mortgage penalty formulas exist, for different Mortgage products, terms, and types. Plan to pay the greater of a three month interest penalty OR a interest rate differential penalty.
Do you have a specific question about your Mortgage? Call, email or text me about it.
Talk soon,
Chad Moore
