If you’ve tried to early renew or refinance your mortgage in the last few years you’ve discovered that your mortgage penalty can be substantially more than you thought it would be. You probably questioned the mortgage penalty calculations as it didn’t seem like current rates were much lower than yours so why would the penalty be so high. In this article, we give you some information on how the banks have managed to manipulate penalties so they are higher than they should be and what options you have to counteract this.
First of all, on fixed rate mortgages, all lenders usually charge you one of two penalties. It is the greater of 3 months interest or the interest rate differential. 3 months of interest is usually a pretty small penalty (less than 3 months of payments). The interest rate differential is a whole other calculation and is determined as follows.
Let’s assume you have a 5 year fixed rate right now of 3.80% that you got 3 years ago. This would be a discounted rate off of the posted rate. Your posted rate may have been around 5.3% when you got the mortgage. Now let’s assume you want to pay out the mortgage with 2 years left in your term. To calculate the penalty the bank will need to determine what the posted rate is on a 2 year mortgage. Let’s say for example this 2 year posted rate is 2.80%. If you have a $300,000 mortgage here is how the penalty is calculated:
Posted rate on your mortgage: 5.3%
Less Posted rate for time left: 2.8%
Difference: 2.5%
Multiplied by your balance: $300,000
Equals: $7,500
Multiplied by years remaining: 2
Total penalty: $15,000
This is a very real scenario and based on these rates you would have to pay this $15,000 mortgage penalty just to get into a new 5 year fixed rate of around 3.69%. So what have the banks done in the last several years to ensure their penalties remain high even though customers are getting out of one set of only to get into another set of very similar rates? You would think that if your rate was in the 4 – 5% range that your penalty would be high as you are trying to break out of that contract for a much lower rate. However you wouldn’t think that by going from 3.8% to 3.69% that the penalty would be so high. Well here is what the banks have done.
Over the last several years banks have artificially left the posted rate on their 5 year term high. They then offer you a deep discount to get you your discounted rate. Rather than lowering the posted rate they have just increased the discount. So what is this significance of this? The higher the posted rate on your mortgage, the bigger the difference the bank will create when it calculates the above mortgage penalty.
The other big thing they do is to leave the posted rates on the shorter terms (1 – 3 year) quite low. They don’t offer big discounts on the shorter terms. They simply leave the posted rate low and give you a smaller discount. This also creates a bigger spread when they take the posted rate on your 5 year term and minus the posted rate for the time left. It is a very clever manipulation that most people don’t consider.
Most people take 5 year terms so they keep the posted rate on this term really high. Then they keep the posted rates on the shorter terms really low. This creates a very large spread between the two sets of rates and dramatically increases your penalty even though often you are not decreasing your ACTUAL RATE by that large of a spread. The average person tries to get out of their mortgage within the first 4 years so the banks know they have your in their claws!
The banks can do this because they control their posted rates and most mortgage consumers have no clue and don’t consider this when getting a mortgage. We have a couple of alternatives for you that may help you to minimize the impact of this manipulation.
First of all, consider a variable rate mortgage. These types of mortgages fluctuate with prime rate so they do carry a bigger risk than fixed rate mortgages. However, they only carry a 3 month interest penalty which is usually very bearable.
The second option is to ask us about the non-bank lenders we use. We have access to many lenders that don’t have branches like the banks. They offer great online & phone service but just don’t have bricks and mortar structures like the banks. In most cases their rates are the same or better and all of the terms & conditions of their mortgages are usually the same as the banks. They are federally regulated lenders and are often under tighter scrutiny than the banks. So why would we mention these lenders versus your traditional banks and credit unions?
Many of these non-bank lenders don’t have your traditional “posted rates” like the banks do. Their rates are their rates. This means that when you get a 5 year fixed rate right now at let’s say 3.69% then that is their posted rate & their discounted rate. There is no difference. This makes a huge difference in penalty calculations by virtually eliminating most of the spread in the calculation we showed you above. So rather than having a penalty in the tens of thousands of dollars your penalty might only be a couple of thousand.
Many customers end up trying to get out of their mortgage before their term is up. Dealing with a non-bank lender can help severely lessen the impact of high penalties that the banks will most definitely charge you.
If you need more information regarding mortgages or if you need any advice on your personal situation please contact our office at 604-556-3893 or email at alex.kotai@ymscanada.ca.
For more information on our mortgage products and your preferred Abbotsford Mortgage Broker please visit our website at www.ymscanada.ca.