The recent drops in interest rates in Canada have been welcomed news to a lot of Canadian homeowners. However, to some people who are selling homes where they have higher rates from the last 3 years this can be a problem in terms of mortgage payout penalties.
The surprising thing when dealing with Sellers is that they rarely know exactly how a mortgage prepayment penalty works. They never took the time to understand this important factor when they first mortgaged their property or perhaps more importantly, it was never really explained properly to them.
When you elect to have a closed mortgage there are limited prepayment privileges ranging anywhere from 5% to 25% of the principal of the mortgage on an annual basis. Typically, there is also the option to increase your mortgage payment by a maximum amount each year.
Go above these limits and you will likely incur a mortgage penalty. We typically see mortgage penalties being incurred either from a sale or a refinancing of the property. How the penalty is calculated depends on the type of mortgage you have.
When you have a closed and fixed rate mortgage, the mortgage penalty is typically applied on the basis of the greater of the payment of 3 months of mortgage interest or the interest differential. Understanding 3 months of interest is simple enough to do but the interest differential is a little more difficult and of greater concern. Essentially, this is the difference between the amount of interest you would be paying for the balance of the term of your mortgage and the amount of interest you would be paying if the interest rate were equal to the bank’s current posted rate for the balance of that term.
Seems innocent enough except for the fact that we have seen interest differential penalties in the tens of thousands of dollars. This can and will potentially affect your return on your property and in some cases has resulted in Sellers having to pay money in order to be able to sell their properties.
If you have a variable rate mortgage the penalty is usually set at 3 months’ interest which is fairly easy to determine. Nevertheless, you will incur a penalty.
What can you do about mortgage penalties? First, understand what the mortgage penalties are for the mortgage product you are contemplating.
Second, understand what your purpose of buying a property is. Are you intended to sell the property relatively soon or hold on to it for longer? Match your term and mortgage product to your intentions.
Third, engage your banker or mortgage broker in a full and frank discussion of what your needs are and how prepayment costs can be minimized. There are sometimes options to do what is called a “porting” of your mortgage which allows you to move your mortgage to a new property you purchase within a certain period of time. This is not always the best option and you will have to requalify, but it does provide an option.
Ultimately this is an important discussion to have with your mortgage representative before you decide to sell or payout your mortgage. Being prepared is always the best option.
By Ron Thibeault – Lawyer
LeClair Thibeault, Barristers & Solicitors
