The federal government recently announced the Code of Conduct for Federal Regulated Financial Institutions. It’s a series of consumer protection measures for borrowers. One of the changes announced is a new mortgage code that will require that federal financial institutions provide more information about how prepayment charges are calculated. Essentially, these charges are penalties imposed on borrowers when they want to pay out their mortgage early.
Prepayments are usually driven by the need to sell your home or re-mortgage because of life’s circumstances. When you lose your job or get transferred. When you have to consolidate your debts. When you unexpectedly have to make room for another child. For the most part, these situations are already plenty stressful without having to deal with excessive penalties as well.
Penalties were first introduced several decades ago to compensate lenders for early payouts. Typically, they charged the greater of three months interest or the interest rate differential (the difference between your mortgage interest rate and the current rate offered by the bank), if you wanted to get out of a fixed-term mortgage. That seemed like a substantial penalty at the time. If, like many people, you turned around and took out another mortgage from the same lender, they often waived the penalty.
All that changed in 1999 when CMHC ditched the long-standing prepayment privilege and made it a “non-mandatory” requirement. That left lenders free to impose their own prepayment penalties on CMHC-insured mortgages. With no specific formula to determine what the interest differential might be as part of the penalty calculation, the banks came up with their own murky guidelines that masked significantly higher prepayment penalties. Since then, borrowers have practically had to be psychic in order to assess what that penalty might be.
The purpose of the new Code is to ensure that “federally regulated financial institutions provide enhanced information” with respect to any mortgage that has a prepayment clause so that borrowers can make informed decisions about prepaying their mortgages.
They’ll have to explain how they calculate the prepayment penalty so that you can make an informed decision when and if you sell or re-finance your home.
Lenders will also have to provide information that a borrower can use to pay off their mortgage faster without triggering the prepayment charge. Typically, there are options to make a lump-sum payment annually, increase the monthly payment by a designated amount or to increase the frequency to weekly or bi-weekly. These options can save you a lot of interest over the life of a mortgage.
This information will be useful for borrowers trying to decide which lender is actually offering the best deal. The lowest rates often reflect mortgages with unreasonable prepayment options and penalties. You’ll have to look at all of the features of a mortgage and how they relate to your personal situation to make an informed decision.
Other bells and whistles will include access to financial calculators that will allow borrowers to estimate the prepayment penalties and a toll-free number with a real live person knowledgeable about mortgage prepayments on the other end.
All in all, it’s a big improvement. The next logical step would be for government to implement the standardized mortgage penalty calculation that they promised in the 2010 federal budget. All that transparency might be too much to expect.
Deb Abbey is a real estate agent at Royal LePage City Centre. You can contact her at abbeypartners.ca.