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3 Apr

Clarifying Mortgage Penalties


Posted by: Kimberly and Cindy Walker

Last month, the federal   government published a Mortgage Prepayment Code to ensure borrowers are   better informed by lenders (federally regulated institutions) when it comes   to situations where mortgage prepayment penalties may be charged – namely,   for the purpose of clarifying interest rate differential (IRD). 
  This is a positive step, because IRD calculations and penalties have   traditionally been very confusing to borrowers.

IRD is a charge many borrowers face when paying off a mortgage   prior to its maturity date, or by paying the mortgage principal down beyond   the amount of annual allowable prepayment privilege limits. And IRD penalties   can prove quite costly depending on the remaining mortgage term.

IRD is based on: 1) The amount that is being prepaid; and, 2)   An interest rate that equals the difference between the original mortgage   interest rate and the interest rate that the lender can charge today when   re-lending the funds for the remaining term of your mortgage.

Most closed fixed-rate mortgages have a prepayment penalty   that is the higher of three months’ worth of interest or IRD.

The new code requires that lenders “provide the information in   language, and present it in a manner, that is clear, simple and not   misleading.”

The Code requires lenders to provide, among other things:

1. Annual Prepayment   Information. This includes such things as prepayment privileges that the   borrower can use to pay off their mortgage faster without having to pay a   prepayment charge. Examples include making lump-sum prepayments, increasing   the regular payment amount and increasing the frequency of the payment to   weekly or bi-weekly. Lenders


must also inform borrowers of the dollar amount of the   prepayment that the borrower can make on a yearly basis under the terms of   their mortgage without having to pay a prepayment charge. As well, an   explanation must be provided on how the lender calculates the prepayment   charge for the borrower’s mortgage (for example, a certain number of months’   interest or IRD).

2. Information Provided When   Borrower Faces a Prepayment Charge. If a prepayment charge   applies and the borrower confirms to the lender that the borrower is   prepaying the full or a specified partial amount owing on their mortgage, the   lender will provide, among other things, a written statement to the borrower   including the applicable prepayment charge and a description of how the   lender calculated the prepayment charge (for example, whether the lender used   a certain number of months’ interest or IRD). If the lender used IRD to   calculate the prepayment charge, the lender will inform the borrower of: the   outstanding amount on the mortgage; the annual interest rate on the mortgage;   the comparison rate that was used for the calculation; and the term remaining   on the mortgage that was used for the calculation.

3. Enhancing Borrower   Awareness. To assist borrowers in better understanding the consequences of   prepaying a mortgage, lenders will make available to consumers information on   the following topics: differences between various types of mortgages; ways in   which a borrower can pay off a mortgage faster without having to pay a   prepayment charge; ways to avoid prepayment charges (for example, by porting   a mortgage); how prepayment charges are calculated, with examples of the   prepayment charges that would apply in specific circumstances; and actions by   a borrower that may result in the borrower having to pay a prepayment charge.

Click here for full details of the code   requirements from the federal finance department.

As always, if you have questions about mortgage penalties, or   other mortgage-related questions, I’m here to help!