November 28, 2011
Penalty Calculations—The Missing Pieces
Globe & Mail columnist Ted Rechtshaffen, a CFP, recently wrote about this very topic. He says: “My mortgage breakage cost truly is a mystery…I have read my mortgage contract…It can’t be found in the fine print.”
Like many banks, his (TD Bank) explains how to calculate its penalty, but people have to deduce the numbers to plug into the formula themselves.
Those numbers include:
- The contracted interest rate (easy enough)
- The posted rate at origination (not as easy)
- The months left on the term (easy)
- The relevant comparison rate (not as easy)
- The current mortgage balance
To confirm these numbers, the borrower generally has to call his or her lender.
Wouldn’t it be nice, however, if you could log into your lender’s website and get this information with one click? It would, but lenders would much rather you call them for it. That way they can try to sell you a new mortgage.
A key point Rechtshaffen makes is that some lenders go out of their way to muddy the waters with respect to mortgage penalty calculations. They do that by:
- Not including certain inputs for calculating your penalty in their mortgage contracts (like the posted rate); and/or,
- Not telling you where to get the inputs on your own; and/or,
- Not clearly explaining (with examples) which term to use when determining your comparison rate; and/or,
- Writing penalty explanations in language that almost requires a law degree.
Penalty calculation shouldn’t be this cryptic. CAAMP says that 47% of people who refinance before maturity have to pay penalties. (It’s actually more than that if you include refis with blended rates [which have penalties built in].) So it’s not like this is some infrequent obscure need that borrowers have.
Lenders who believe they have their customers’ best interest at heart should provide a web page that clients can log into. It should provide an instant penalty quote, with a comprehensible explanation of how that penalty was calculated, showing the math.
RBC has a semi-workable solution with its penalty calculator. Unfortunately, you have to fill in the blanks yourself and few people will know what to enter for things like the “Discount off posted rate.”
In any event, one of the nice benefits of not getting a big bank mortgage is that your penalty is often based on discounted rates instead of posted rates. That often saves people hundreds or thousands of dollars. It’s even more meaningful given that most people break their five-year fixed terms in 3.5 to four years on average.
Sidebar: Be aware that some smaller lenders (like Industrial Alliance, Bridgewater Bank, etc.) have more complicated penalties, sometimes based on bond yields.
At times, those penalties can be even more painful than a big bank penalty.
This all goes to show the importance of discussing penalty policies with your mortgage planner…before settling on a lender.
Rob McLister, CMT