Has this happened to you? After hearing about the great new low interest rates, you decide to refinance your mortgage to the lower rate. However, when you go into your bank to make the changes, your bank’s financial advisor tells you that you are on the hook for some very expensive penalties if you decide to re-finance. What do you do?
Image: Quinn Dombrowski / Flickr
This is becoming increasingly common. The Ombudsman for Banking Services and Investments, which looks after complaints consumers have made about their banks including mortgages, have seen a jump in the number of complaints filed. Even Ottawa is getting involved. Flaherty mentioned in his March 4th budget that they will look into standardizing how banks calculate these prepayment penalties.
Even more troubling for a consumer’s perspective, many banks don’t actually explicitly state how they calculate their penalties. This can make you more reluctant to refinance your mortgage, which is obviously what the banks want to do.
In general though, for a variable-rate mortgage, you are looking at paying about three months’ interest if you want to refinance. Fixed-rate mortgages can also charge three months, but some of them charge the Interest Rate Differential (IRD). This is, as it sounds like, based on the difference between what the customer is currently paying, and what they would be paying if they renewed their mortgage. It is difficult for consumers to calculate on their own, and this is where the difficulties creep in.
And this is where some of the tricks come in: some banks calculate the IRD by basing it on the posted mortgage rate – the one that no one actually pays. The result is that you end up paying more than you might think you would be paying.
Using the IRDs to calculate the amount you would have to pay is usually okay: of the two methods, IRD or three months, IRD is usually cheaper. However, in this unprecedented interest rate environment, the three month penalty is turning out to be cheaper. Hence consumer anger at the difficult-to-calculate IRD. The IRD looks like a veiled cash grab compared to the simplicity of a three months’ penalty. Nevertheless, in most instances it would be advantageous for you to use the IRD.
This confusion simply highlights the fact that you should always make sure that you understand your mortgage documents fully before you start signing things. And if you are thinking of refinancing, talk to your mortgage specialist in detail to ensure you are making the right decision, and fully understand all of the potential costs.
Heleen Jacobsen
Broker of Record with InfoMarket Group GMAC Real Estate
www.infomarketgroup.com
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