Early exit from closed mortgage can cost you dearly

But life is full of surprises — and if you have to sell or refinance before the mortgage term ends, you can be hit with a monstrous penalty.

Take Douglas Clinton Govier Jr., who sold his house this year. He had just over six months left on a closed five-year mortgage with CIBC.

“I was charged over $12,000, which was more than one full year of interest,” he says. “I expected to pay a reasonable penalty, but not one as unreasonable as this.”

He asked on at least two occasions how the penalty was calculated and couldn’t get an answer. He was told that the amount could not be reduced unless he took out another mortgage with the bank.

Here’s the problem: Govier was selling because he couldn’t afford to live in his house any more. He had hoped to use the sale proceeds to pay off bills, but now he was still in debt.

I asked CIBC to review the complaint, but the penalty stayed the same.

“I am truly disappointed and frustrated,” Govier says.

I have a friend named Eric, who was selling his house in Toronto and retiring to Ecuador. He wanted a lower cost of living in retirement.

With 18 months left on his five-year mortgage, he figured he could make an early exit without too much pain. He was stunned to learn otherwise.

“I always knew that cancellation of a mortgage contract involved a penalty of a few months’ interest,” Eric said. “But I’m finding that Laurentian Bank is going to ding me for a $13,000 penalty on a $330,000 balance.”

If interest rates go up after you take out a closed mortgage, you can usually get out early by paying a penalty of three months’ interest. Your lender can sign up a new borrower at a higher rate.

But if interest rates go down, you have to pay a penalty that is much higher than three months’ interest. It is based on the interest rate differential (IRD) between your initial rate and the current rate until the end of the term.

An IRD penalty can be a shocker, since your lender wants compensation for having to break your higher-rate mortgage and sign up a new borrower at a lower rate.

Lenders calculate these penalties as they wish. There isn’t a formula that everyone has to follow.

The federal government talked about standardizing the penalty calculations for banks a few years ago, but opted for more disclosure instead.

If you received any rate discounts or cashback rewards when you took out the mortgage, you may have to pay them back on your way out the door. This, too, inflates your penalty.

Take Ashley de Moscoso, who was selling her condo after three years to buy a family home. She had a five-year mortgage with TD Canada Trust and calculated the penalty at just over $2,000 on a $123,000 balance.

“When I met with TD, I was quoted $5,181, with no explanation given. After finding no reason why it should be so high, I called and they told me it was because I received a discount of 1.5 percentage points.,” she told me.

“This was certainly not on the contract I signed back in 2009. They said the discounted rate on my mortgage was listed on my annual interest statements and seemed to think this was sufficient disclosure.”

When TD suggested transferring her mortgage to the new house to avoid paying a penalty, Moscoso said: “Considering how rude and difficult they are being, I would frankly never deal with them again.”

If you opt for a closed mortgage, ask your lender about transferring it (known as porting) if you plan to move to a new property. Some allow it and some don’t.

Also, find out if the lender is giving you a discount that will be thrown into the IRD calculation when you get out of a mortgage prematurely.

“Some lenders don’t make you pay for the benefit of getting a discount,” says Steve Garganis, a mortgage broker with Mortgage Intelligence.

“My advice to anyone choosing a new mortgage is to ask how the penalty is calculated. If you see anything that says you must pay for the discount or some other extra cost, then move on. You don’t need that product.”

First National Financial LP, Canada’s largest nonbank mortgage lender, does not claw back a rate discount, Garganis says. Try the company’s penalty calculator to see how much it costs to prepay your mortgage.

Finally, don’t make low rates your only criterion when choosing a lender. Ask the right questions ahead of time, since you don’t want to be hit with an inflated penalty calculation later on.

Source: Toronto Star