Pre-payments to Cut Penalties

Mortgage-PenaltiesNothing makes a mortgagor curse his or her lender’s name faster than a big fat pre-payment penalty.

One way to lessen the penalty sting is to make a lump-sum pre-payment before discharging your mortgage. That lowers the balance upon which the penalty is calculated.

The problem is, people often don’t have wads of cash floating around to make a pre-payment.

One solution is to borrow funds for a short period—be it from family, an unsecured line of credit (ULOC), or wherever.

This is where banks have an advantage over many brokers. Banks can often arrange unsecured credit lines for mortgage customers whereas most brokers don’t.

That may be changing, however. We hear of two banks working on distributing unsecured credit lines through the broker channel. That will be a win for brokers and save them from having to outsource ULOCs to bank branches (who have a funny way of competing with brokers for mortgage business).

On a separate note, last Friday we came across a new pre-payment loan service. It’s a start-up company aimed at lending you money to make a pre-payment. In return, it takes a portion of your penalty savings. We’ve seen one small outfit offering this kind of service before, but this new firm should make the pre-payment loan concept more mainstream.

We’ll report on these new offerings in detail once the info has been made public…

Sidebar:  If you’re planning on making a pre-payment to lower your penalty, ask your lender how far ahead you need to do it. At a minimum, you’ll want the lender to record the pre-payment before you request a discharge statement.

Also keep in mind: In some cases, lenders don’t allow a pre-payment to count towards penalty reduction if the pre-payment occurs within 30 days of discharge.

Rob McLister, CMT

  1. I work at a credit union and we always calculate the prepayment privilege in the pay out so it doesn’t have to be made in advance. I though everyone did it that way.

  2. Hi Jerry,
    Most don’t. Some will allow it but the lawyer has to ask for this specifically when sending in the discharge request.

  3. Here’s a simple way for people to avoid hefty penalties: take a variable mortgage or a hybrid mortgage and call it a day.
    For some reason Canadians are just absolutely horrified with variable mortgages. 90% of consumers in Europe have a rate that floats and in Canada it’s exactly the opposite. ARMs/VRMs make up barely 10% of the market with 90% of consumers electing to take a fixed rate mortgage when they are more than capable of handling a VRM and at the end they are left at the mercy of their lender.
    With some mortgage penalties being as high as the price of a new car, is it really wise to borrow money to pay off the penalty to get out of one loan? Talk about digging a deeper grave! Even if the bank does arrange for a ULOC, how quickly can most consumers pay off a $20,000 balance? Not quick that’s for sure, and let’s not forget that ULOCs are priced at a higher rate than SLOCs.

  4. I thought that variable mortgages were more like 25-30% of the market. You might want to recheck your numbers Lior.

  5. Hi Lior,
    Thanks for the post. Making a pre-payment before breaking a mortgage often saves a homeowner $1,000 or more in penalties—sometimes much more (even after refi expenses).
    The line of credit can often be rolled into the new mortgage, thus eliminating the payoff concern you raise. Depending on the client and situation, this strategy can make good economic sense.

  6. Hi Jim,
    You are correct, based on the latest data we have. CAAMP’s last figures shows 29% of borrowers take a variable. Ipsos Reid’s 2010 survey shows 32%.
    These figures are from last year so keep an eye out for CAAMP’s spring mortgage report (due out soon). It’ll have the latest numbers.

  7. Jim:
    My information is based on a BoC paper that came out in March. I wouldn’t be surprised if the numbers are a bit higher in the interim as a result of consumers being pitched very low rates for refinances and debt consolidation based on a variable rate. About two months I received an ad in the mail from a major brokerage showing the consolidation math based on a variable rate. The monthly savings are somewhat misleading because the payment amount computed doesn’t take into account rising interest rates but that’s another story. It will be a more realistic reflection of market sentiment once rates start to rise.

  8. Hi Rob,
    Absolutely, posting a pre-payment can definitely decrease the penalty amount. But in order for a pre-payment to be made, the consumer needs to have the money. If they can’t provide it from their own savings then it will have to be borrowed from somewhere. Even if the LOC is rolled into the mortgage, the consumer still ends up being deeper in debt. Going variable would eliminate this hassle as the penalty is 3 months at prime. Not small change in itself but definitely not $30,000. But then again this depends of the consumer’s appetite for risk.

  9. Hi Lior,
    Let’s sort this out together. Here are the key points:
    * The money borrowed off the LOC is used to reduce a person’s mortgage balance proportionately.
    * Most people only borrow money for a pre-payment for roughly 20-40 days.
    * The money borrowed from the LOC is typically rolled into the new mortgage, bringing the LOC balance to $0.
    As a result of the above——the consumer does not end up deeper in debt (materially anyway), and they save on their penalty to boot!

  10. “Going variable would eliminate this hassle as the penalty is 3 months at prime”
    This is incorrect. The penalty is based on 3 months interest at the rate the client is paying the date the mortgage is broken, not based on prime.
    This is actually good news though, as often the penalties are calculated at a rate far less than prime.

  11. Unfortunately our government does not agree. With the MQR rate so high it forces people to take a five year term when it may not be in their best interest. Maybe the government can get back to work and get busy on passing a law to control prepayment penalties.

  12. Mike, can you provide an example where a variable rate penalty is calculated on something other than the rate the client is currently paying? I have never come across this before….

  13. I used to have a mortgage on my condo thru RBC on a variable interest rate, but closed. When I sold my condo, they charge me a hefty penalty, I’d say around $11k.
    The penalty was calculated based on the difference of interest rate when I initially took the mortgage and the n umbers of the months left to maturity.
    In my opinion, all banks are crooks.

  14. What an ignorant statement! When banks enforce a fixed contract that includes full disclosure, there is nothing illegal or crooked about such action.
    All your statement demonstrates is many people who get a fixed mortgage don’t know what they are signing. Ignorance is not a defense.

  15. to be fair, he did say he had a variable rate mortgage, not a fixed mortgage so to have to pay such a large penalty as $11,000 is very unfortunate. And to suggest Banks are in it for anything other than making excessive profits is to be very naive indeed.

  16. Please explain how you arrive at 11K penalty on a RBC, variable rate mortgage? Was this a 1.5M mortgage?
    Fixed or variable? it doesn’t matter, bank mortgages come with full disclosure which means the opinion that they are crooks is slander.

  17. You do not have to have a $1.5M mortgage to incur a penalty of $11K! I’ve seen it time and time again with many of my clients who have balances averaging $200K. I think what we need to do, as professionals,is ensure that clients have the proper mortgage product AND they know exactly what they are signing!! NO surprises!!!
    Banks are not charities (we all know that) and explaining the business sense should clearly show penalties, as outrageous as they can be, are not criminal.

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