Bank Payout Penalties: The math behind “how they get you!”
This is a great article with the perfect math example.
Remember, there is also the catch of the collateral charge by the big banks that makes it cost about $2500 to leave your bank when your term is up.
Add these 2 things together and the better overall deals are from mortgage brokers.
Mark Herman, Top Calgary, Alberta Mortgage Broker for renewals and home purchases.
by: Angela Calla, AMP.
When choosing between mortgages, knowing how different lenders calculate penalties can be essential. The market and your needs easily shift during the term of your mortgage and the last thing you want is a painful penalty in order to get out early.
Penalty formulas differ radically, depending on the lender. A major bank, for example, will have a considerably higher penalty than a broker-only wholesale lender. Advice on how to avoid painful penalties is a key benefit of working with a mortgage broker.
You need to ask one important question right off the bat: What rates does the lender use to calculate its penalty? The actual discounted rates that people pay, or some artificially high posted rate? Hopefully the former.
Below is an example of how two lenders calculate the same “interest rate differential” penalty in different ways. Ask yourself, which one would save you the most money?
| Penalty #1 – Broker Lender | |
| Contract Rate (The rate you actually pay) | 4.19% |
| Current Rate (Today’s new rate, closest to your remaining term) | 3.09% |
| Differential (Contract Rate – Current Rate) | 1.10% |
| Remaining Balance | $229,000 |
| Remaining Months | 16 |
| Penalty Formula: Remaining Balance x Differential ÷ 12 x Remaining Months | $3,358.67 |
| TOTAL APPROXIMATE PENALTY | $3,358.67 |
| Penalty #2 – Major Bank | |
| Contract Rate (The rate you actually pay) | 4.19% |
| Current Posted Rate (Today’s new posted rate, closest to remaining term) | 3.39% |
| Original Posted Rate (At the time you got your mortgage) | 5.99% |
| Original Discount (That you received off the Original Posted Rate) | 1.80% |
| Differential (Contract Rate – (Current Posted Rate – Original Discount)) | 2.60% |
| Remaining Balance | $229,000 |
| Remaining Months | 16 |
| Penalty Formula: Remaining Balance x Differential ÷ 12 x Remaining Months | $7,938.67 |
| TOTAL APPROXIMATE PENALTY | $7,938.67 |
As you can see, there can be quite a difference in prepayment charges when you leave a lender early – over $4,500 in this example. And this is a modest hypothetical calculation. Bank discounts today are on the order of 2.00 percentage points off posted, instead of the 1.80 I’ve used here.
Some lenders will even charge an abnormally high penalty (like 3% of principal) despite you being close to the end of your mortgage term. They do this as a retention tool to keep you from leaving. Others will charge a “reinvestment fee” on top of the penalty, tacking on another $100 to $500 in expenses.
In short, penalties can be thousands—or even tens of thousands—higher depending on the lender’s specific calculation formula, mortgage amount, rates and time remaining until maturity. Extreme penalties are not only more expensive, they can even keep borrowers from moving because the amount eats into the money they’ve got for a down payment and closing costs.
Worse yet, some lenders have a “sale only” clause in their mortgages, meaning you can’t even leave them unless you sell the home. If you think, “Oh, that’s no big deal. I don’t plan on selling,” think again. Throughout every path in life, there are moving parts and uncertainties. When you get married, do you plan on divorcing? Likely not. Did you predict the company you were with for 20 years could downsize, or your pension would be reduced or cut? Can you guarantee your health will never throw you a curve ball?
We all want to believe that none of the above scenarios will come to pass, but they can and do. And when they do, what a relief it is to have options.
And last but not least, there is the refinance consideration. If interest rates fall 0.5-0.8%, (which may seem unlikely but is certainly a possibility) there may be opportunities to lower your borrowing costs. But you can’t do that unless you’ve got a low-cost way to renegotiate your existing contract. And as we’ve seen above, that cost is not based on just your interest rate alone.
Another example: When the rates are the same at the bank and the broker = broker deal is significantly better.
Here is what happens when the Current Posted Rate (Major Banks) = the Current Rate (Broker Lender) at 3.09%
Differential (Contract Rate – (Current Posted Rate – Original Discount)) = 2.90%
==> (4.19% – (3.09% – 1.80%)) = 2.90%
==> (4.19% – 1.29%) = 2.90%
Therefore:
Penalty Formula: Remaining Balance x Differential ÷ 12 x Remaining Months
==> $229,000 x 2.90% / 12 * 16
==> $8854.67
Moral of the story – talk to a broker and understand your penalty calculations.
You can talk to your major bank as well, although I don’t think they can spin the penalty calculation conversation into a favourable one for themselves.
SUMMER = when interest rates are going to rise!!!
Hot off of the press – below the Bank of Canada expects mortgage rates to rise in the summer of 2014 !!!
Warren buffet said everyone knows what is going to happen – [rates rising] – but no one knows when. Now we know, or at least we think we know. The article does a good job explaining that when the market rises, bonds have to pay more to get people to buy them and this increases the bond rates. Surprise, higher bond rates = higher mortgage rates.
So … pay off that debt, the line-of-credit, the credit cards, car loans and all the rest now while you can. And, think about locking in your mortgage if you are in a variable, and getting your docs in for a 120 day mortgage rate hold to be triggered when we find out from the banks that rates are going to rise. The 6 month clock is ticking.
Mark Herman
Long-term rates may rise soon, Stephen Poloz says
Bank of Canada governor predicts pressure on bond yields as Fed continues tapering
CBC News Posted: Jan 07, 2014 1:22 PM ET Last Updated: Jan 07, 2014 2:34 PM ET
Bank of Canada governor Stephen Poloz says he expects long-term interest rates to rise this summer as the U.S. Federal Reserve continues tapering, but he believes that would be a positive development.
Poloz, who was named Canada’s top central banker in May, said he believes that the U.S. Fed will continue to taper its bond-buying program throughout the year and that will create market pressure on bond yields.
“In the context of a firming global economy, especially the U.S., we’d expect to see some upward pressure in market interest rates, long-term rates in particular, where the quantitative easing has its primary effect,” Poloz said in an interview with Amanda Lang on CBC’s The Lang & O’Leary Exchange to be aired later today.
“So as a tapering occurs we might expect to see as we saw in the summer some increases in long-term rates, most of it seems to be priced in,” Poloz added.
The Fed reduced its buying of U.S. bonds to $75 billion this month, after a decision announced at its December meeting to reduce the stimulus program meant to keep interest rates low and grow the American economy.
The market handled the tapering announcement well, though it put pressure on bond yields, including Canadian bond yields, Poloz said. That would lead to an increase in long-term fixed mortgage rates, though the Bank of Canada would not increase its benchmark rate.
…
Poloz said he believes a long-term rate rise wouldn’t greatly hurt the Canadian economy as the housing market appears to be heading for a soft landing and consumer spending, which has kept the economy strong these last few years, must come down to bring down household debt levels.
The Bank of Canada kept its benchmark interest rate at one per cent in December, but there was an uptick in mortgage rates last summer after bond yields rose. …