The Sting of Bank Penalties

IRD-penaltiesLenders like to keep you in their web as long as possible. If you’ve got a closed mortgage and try to escape, they sink their penalty fangs deep in your wallet.

To the surprise of many, there are dramatic differences in how those penalties are calculated, even at the same bank.

CIBC, for example, sells mortgages under multiple brands, with “CIBC” and “FirstLine” being the most popular.

Recently, we did an interest rate differential (IRD) penalty calculation for a FirstLine customer who wanted to refinance. This client was fortunate to have closed his mortgage at FirstLine instead of directly with CIBC.

Had that customer chosen a CIBC-brand mortgage instead, his penalty would have been $3,210 higher—even though it’s the same parent bank in both cases.*

This difference in penalties is explained by each lender’s penalty formula. One uses posted rates and one uses rates that are more discounted. (See IRD Penalty Comparison Rates for more background on penalty calculations.)

As we’ve written before, painful IRD penalties can be a serious downside to choosing a Big 6 Bank mortgage.  It’s something bank consumers rarely think about….until they need to break their mortgage (and most do before five years.)

Major banks will rarely admit how bad their IRD penalties are relative to the competition. Fortunately, many smaller lenders offer an alternative by refusing to adopt big-bank-style calculation methods.


* Assuming the same rate, balance, payments, etc.


Rob McLister, CMT

  1. Great Post Rob- It would be interesting to also compare the Variable Rate prepayment penalties plus any reinvestment fees. I have seen some large Bank Lenders charging IRD on their VRM as “the Bank must be compensated for the interest lost”, which translates into if you obtained a discount on the mortgage originally you will have to repay that portion of the Variable Rate as well. Most folks do not read their Standard Mortgage Terms until it is too late.

  2. Hi Rob,
    I am a big six lender but religiously use your web site to keep up to date. Thanks for your work.
    If a client requires to refinance their mortgage mid term the penalty can be avoided using a same term blend. If the clients are looking to relocate to a new property they can port their fixed term mortgage to a new property.

  3. Hi Banker
    What you said applies to my situation. Can I ask you some questions on this?
    On a same term blend does the bank build the penalty into the interest rate it charges me? I heard blended rates include the penalty but you just don’t see it.
    What if I have one year left on my 5 year mortgage and I want to blend into a new 5 year mortgage? Do I have to pay a penalty then?
    Thanks a lot
    Michael

  4. Blending doesn’t save you penalty.
    You’re right, penalty is included, the blended rate you receive is high enough so the bank gets the penalty back till your new term expires.

  5. About the 1 year remaining – Yes, you have to pay full penalty as per the formula.
    Some banks allow you to renew 120 days before maturity with no penalty. or you have to wait till the formula used to calculate penalty uses 3 months interest instead of IRD.
    That usually happens roughly around 8 months remaining to the end of the term.
    But in general – there’s no mercy with Big banks in regards to the Penalty. Once they have you in their web, there’s no easy escape early.

  6. There is NO PENALTY with a blend. The new commitment blends the old higher rate with the new lower rate for a combined rate.
    Forgive Observer for she must be “special” ever since falling on her head.

  7. never expect sound financial advice from a “banker”. their advice is aligned with their profit making goal.
    The penalty is there and is blended in your new rate (so you pay it as you pay off your new term). It’s just an illusion for you that you don’t pay it. You pay more than the penalty with blending deals usually.

  8. And let’s not forget some of the Big 6 like TD Canada Trust charge an additional insulting $300 “re-investment fee” on top of their penalties on closed fixed and variable rate mortgages.

  9. Hi Banker,
    Thanks for writing in and for the thoughtful acknowledgement.
    There are definitely instances where a penalty will not apply. On the other hand, penalties do apply in several cases. Those include, but are not limited to, cases where the borrower wants to:
    * switch to the lowest possible rate on their existing mortgage balance maturity (or before the early renewal period, if applicable)
    * extend their amortization to improve cash flow
    * extend their term to reduce renewal risk (i.e. switch into a term longer that’s longer than their remaining term).
    The latter is especially popular today with such low 5yr and 10yr rates.
    Even when a penalty is not paid out of pocket, the rate quoted on most blends is higher than a lender’s lowest possible rate.
    Cheers…
    Rob

  10. With Scotia there is no penalty to blend and extend with RBC and CIBC there is a penalty (added back to the rate)- so it depends on the institution

  11. A bank may not explicitly charge a “penalty” but that doesn’t mean you don’t pay one. Banks simply blend the penalty into the new interest rate.
    You’re saying that Scotia doesn’t upcharge the rate when someone blends and extends? I find that hard to believe.

  12. They were not (for sure 3 Years ago) when I was working there and as far as I know the policy is still the same. I know CIBC does charge it in the rate and so does RBC – not sure about BMO and TD

  13. I have a 5-year old VRM from TD and there is no reinvestment fee according to the statement.
    Things might change though. Is it for their new collateral charge type mortgages?

  14. So a little clarity on blended rates as they seem to be jumbled together into one category… but infact there are two main types below:
    Same term blend: A blended rate were the old mortgage and rates stay intact and new funds can be added to the existing mortgage and the term maturity date does not change. At some FI’sthe new funds can get max pricing (others not so lucky)and as the old term was not broken there is no penalty. Good for those who have large balances to consolidate or equity take outs to bring the higher rate down not so good for limited new funds.
    Extended term blend: Penalty gets blended into the discount on the new term and yes a penalty is applicable here. The rate will probalably go down from the previous one but not always… either way you will end up paying the penalty back throughout the course of the term.
    No one likes paying penalties but having them out there does reinforce why true mortgage professionals are required and why do it your-self, pick the best rate off the net borrowing is rarely best for the average consumer.

  15. Precisely. A lot of consumers aren’t aware of it. Just because they’re not paying anything upfront doesn’t mean they’re not paying a penalty. Instead, the penalty is simply blended into the new rate where compound interest actually magnifies the amount charged over time.

  16. whoops, sorry, not yours Rob. The linked information & site is dated but still gives a decent general idea

  17. Speaking of interest rates and Big Banks.
    I just received a notice from TD that my unsecured line at prime plus 1.25% is moving up by another 1.75% to prime plus 3.0% or 6% . ( slightly more than the cost of living increase !!) I guess I am being penalized for not using it enough ?
    Is this the norm now in unsecured rates ?

  18. Never rely on what “banker in an ivory tower” says … even better – ignore what he writes.

  19. P+3 for an unsecured LOC is still really good and it would be difficult to obtain that rate without security at any other bank. Some unsecured LOC’s at other institutions are getting closer to 10%. I recently purchased a used vehicle through TD and my rate secured by the vehicle is P + 2.99.

  20. Mine at the same bank is moving up by 2% from Prime+2.5% to Prime+4.5%
    Probably because I am using it too much. Or just greed – the banks need to deliver the profits for their shareholders.
    TD made a mistake. They want more money but they will get nothing instead. I am taking my business elsewhere.

  21. Strangely, I just got a notice from the same bank that my unsecured LOC is moving down from prime +3.5% to prime +2%. I’ve used it maybe twice in five years for a few days each time. I figured they want me to use it more.
    (Sadly, this is now at a slightly lower rate than my mortgage. It’s tempting to make a prepayment!)

  22. Apparently TD is readjusting the rates for many (all?) unsecured LOC holders. According to the posts on the RFD forum (http://forums.redflagdeals.com/td-increasing-line-credit-rates-1137249/) the rates are going up and down for different people. I think a “smart head” at TD came up with a new brilliant idea of evaluating their clients (credit rating? LOC use/balance? income? risks?) triggering the rates adjustments. I am just wondering what logic they are using in that exercise. Why would they want to upset people like me who has an excellent credit rating and lots of business with them?
    I called TD and asked to lower my interest rate. Instead they wanted me to lock in a portion of my LOC balance under the current interest rate. This “exciting” offer is valid till May 31. I told them I was not interested since I would take my business elsewhere.

  23. Prepaying your mortgage with lower rate LOC may be not a bad idea. Just keep in mind that once you prepay your mortgage it may be very difficult to take your prepayment money back from the mortgage in case you need that money. At some point down the road the bank can reassess your LOC rate and jack it up if they feel like that.
    If you are paying high fixed interest rate on your mortgage and have enough equity in your property you could think of getting a secured LOC at Prime+0.5…1% (it may cost you legal fees to register and possibly an appraisal fee) and prepay your mortgage. Then you can lock in a portion of your secured LOC under a fixed term and interest rate for 1-2 years (FRAO). Although TD uses their posted mortgage rates for the FRAO they have internal document with “discretionary” discounts from their posted rates. What is interesting that the discounts are higher if you wait 120 days after opening the HELOC. For example, you are looking to lock in for 1 year and their poster rate is 3.5%. If you lock in right away your discounted rate may be 3.0% but if you wait for 120 days a deeper discount will apply giving you a lower rate of 2.8% (provided the posted 1-year rate did not change – they will not hold the rate for you).

  24. Thanks, tcm1, for the detailed analysis. We did look into using a HELOC to prepay last year but yes, we were concerned about the fees involved considering we are likely to move in 1-2 years and the HELOC would then be closed. I did run the numbers and a lump sum from the unsecured LOC would save us only about $25 since we only have 8 months left to renewal and the LOC limit is not very high (nor the rate difference very much, once it kicks in in April).
    We will definitely be using a broker this time and exploring all variables, particularly the penalties! In hindsight it was probably worth breaking the mortgage a couple of years ago but $12k was a steep price to pay.

  25. arguing over the same thing basically.
    Either way, you’re not getting out of your fixed term and getting into a new lower rate mortgage without paying a price. You either break the mortgage and pay the penalty or you blend the rate.
    In many cases it’s better to break and pay the penalty to get the lower rate. It’s worth doing the math to figure it out.

  26. If there are no penalties why bother giving a blend at all. Why not simply give the client the new rate?
    Seems like ..ahem.. logical thinking. You are a mean s.o.b. Ivory tower someone must have done you wrong somewhere.
    You have been brainwashed.
    Plus you arent trustworthy cos you get so mad LMAO

  27. If there are no penalties why bother giving a blend at all. Why not simply give the client the new rate?
    Good point Lorilee! Any responses to this??

  28. It’s my understanding that most folks don’t receive a copy of the standard charge terms until after they have signed the mortgage documents at the lawyer….by that time it’s too late to change lenders for most borrowers….

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