3-Month Penalties Aren’t Always Clearcut

Mortgage-PenaltiesBreaking a closed mortgage usually results in a penalty. With a fixed mortgage, that penalty is typically the greater of 3-month’s interest or the interest rate differential (IRD).

The dreaded IRD has been debated here ad infinitum, but there’s one thing we haven’t covered yet. There is a subtle twist to some lenders’ 3-month interest penalties that many folks aren’t aware of.

When most people calculate a 3-month interest charge they do so by taking their mortgage balance, multiplying by their interest rate, and dividing by four.

That usually works…unless your lender calculates the penalty with a different rate than your contract rate.

Believe it or not, a few lenders (see below) jack up the rate they use to figure their 3-month penalties. These lenders will typically base your penalty on the posted rate at the time you closed the mortgage, instead of your actual rate.

Let’s examine the difference this makes to the typical mortgage holder.

The average mortgage balance in Canada is $170,000, according to CAAMP. The average mortgage rate is 3.64%, or 1.77% off posted rates.

mortgage-penalty-calculatorTherefore, the penalty for a “typical” mortgagor being assessed a 3-month interest charge would be about $1,547.

By contrast, the 3-month penalty based on posted rates would be almost $2,300.

In other words, lenders who use arbitrary posted rates to calculate their 3-month interest penalties drain the typical borrower of an additional $752 based on a 20-year amortization. That is:

  • About 49% more than other lenders
  • Roughly equivalent to paying a 10 basis points higher rate over five years.

And with more than 50% of long-term mortgage holders breaking and/or renegotiating their mortgage before maturity, penalty calculations aren’t something to blow off.

In case you were wondering, there is no legislation prohibiting this practice.

“There is nothing in the Bank Act (or Interest Act) that stipulates exactly what interest rate should be used in the calculation of a mortgage prepayment penalty,” says Natasha Nystrom, Communications Officer at the Financial Consumer Agency of Canada. “The calculation itself is a business decision.”

Theoretically, a lender can use almost any rate short of usury to calculate your penalty, as long as it tells you in advance.

“The Bank Act does require that all Federally Regulated Financial Institutions (FRFI) initially disclose the manner in which their penalty is calculated as well as a description of the components included in the calculation of the penalty,” Nystrom adds.

Here’s what we’d take away from all this…

When you’re comparing two mortgages and the rates are equal, all other terms are rarely equal. The method your lender uses for penalty calculations is one of many reasons why the rate you get doesn’t determine the interest you pay.

Rates used to calculate 3-month interest penalties on fixed mortgages:

  • ATB Financial – Contract rate
  • BMO – Contract rate
  • CIBC – Posted rate
  • Coast Capital – Contract rate
  • First National – Contract rate
  • Home Trust – Contract rate
  • HSBC – Contract rate
  • ING Direct – Contract rate
  • Manulife – Contract rate
  • MCAP – Contract rate
  • Meridian Credit Union – Contract rate
  • National Bank – Posted rate
  • Scotiabank – Contract rate
  • Street Capital – Contract rate
  • RBC – Contract rate
  • TD Bank – Contract rate
  • Vancity – Contract rate

The “contract rate” refers to the rate you actually pay.

The “posted rate” refers to the non-discounted posted rate at the time you closed your mortgage.

The above list was compiled based on information obtained by surveying lender call centre reps and/or reviewing standard charge term documents. These rates apply to prime mortgages only and are believed accurate. If you have different information, please let us know. Moreover, if you know of other lenders who calculate 3-month penalties based on posted rates, feel free to leave a comment below.

Note: Many lenders let you avoid penalties by porting your mortgage or using a “same-term blend and increase.” Contact your mortgage planner for details.

Rob McLister, CMT

  1. Awesome article Rob. How lenders can justify basing 3 month int. penalties on posted rates is beyond me. The sad thing is that unsuspecting customers are probably never advised about this until they get to their lawyer’s office to sign. By that time, it’s too late to find another lender.

  2. RBC is calculating using the posted rate at the time of your contract.
    You say :
    “RBC – Contract rate”
    This is false, RBC charges the posted rate at the time of contract or (your rate + the “discount” , that actually is the total posted rate at the time).
    It’s all in the contract.

  3. John,
    You are incorrect on this,The calculation used by RBC is worded as follows:
    Three months’ interest is calculated at the current rate on the existing mortgage on the outstanding mortgage balance.
    Thus Rob was correct, the contract rate is used for 3 month interest calculations. You are mixing it up with IRD calcualations.

  4. Rob is right, Arby is right and you John are wrong.
    Read RBC’s mortgage contract:
    I quote:
    “The Prepayment charge will be the greater of:
    (i) Three months interest on the amount prepaid, at the Interest Rate; or
    (ii) Interest for the remainder of the Term on the amount prepaid calculated using the interest rate differential.”
    “Interest Rate means the interest rate that applies to the Mortgage. The Interest Rate and how it is calculated is shown in the Registered Mortgage.”
    See the definitions section. The “Interest Rate” is different from the “Posted Rate.”

  5. I do not have a copy of TD Pre-payment policy howvere did 3 refinances recently of TD variable closed mortgages for clients in which they were quoted the 3 month contract rate penalty over the phone when calling TD… And upon payout were charged an additional amount in all 3 cases called a “Re-Investment” Fee
    I have a feeling that this might be the chargeback of the priginal discount from posted as the amounts seem to match up! Hopefully someone on here can clarify TD’s re-investment fee penalty which is an addition to the 3 month penalty.

  6. Now the question is:
    Where do you find the posted rate for ABC Bank on March 7th 2008?
    Great list, thank you.
    Would be great to have a repository of historical posted rates, listed individually by bank. I have seen charts with averages, but no individual listing for reference. Anyone know if this exists?

  7. Hi Rob
    Excellent article as usual!!
    Have you written the same kind of article for IRD as that is where some of the banks including RBC get expensive and a bit tricky to figure out. I apoligise in advance if you have.

  8. Rob – can you confirm that the CIBC rate holds true on existing Firstline mortgages? I still have about 4 years to go with them, and assume they have the same rules as the CIBC parent?

  9. The re-investment fee ONLY applies if the mortgage is paid in full (ie. cash payout), it does not apply to a port/transfer & would not apply in a refinance situation. We do not charge fees if refinancing for an equal or greater amount than the current mortgage balance. Its under our “replacement mortgage” policy.

  10. Hi Craig,
    Firstline probably uses their “ceiling rate” which is about .3% – .4% higher than your current rate (discount depends on whether your broker was platinum or not).
    If you are in a variable rate, the 3 month penalty is based on prime, not the discounted rate.

  11. Mortgages bearing the FirstLine brand are issued by CIBC Mortgages Inc., a subsidiary of CIBC. FirstLine is a trade-mark, not a company.

  12. I had an RBC mortgage and they charged me the posted rate on the IRD calculation. What’s worse, they would not let me blend and extend either. Having a Vancouver sized mortgage, the difference was several thousand dollars!

  13. Once again, keep your facts straight, there is a difference in the IRD calculation (which the calcuation in your original post refers to) and the 3 month calculation. This article is discussing 3 month penalties.
    I would bet my hat, blue suit and yellow tie that the information in the replies to your original post are correct, and you are spreading incorrect info.
    Oh,one last thing, its good to see you know about EVERYONE’s mortgage dealings with RBC, you must be a busy man considering the amount of clients the bank has across the country.

  14. Based on my experience as a real estate lawyer, it is imperative that borrowers know before the mortgage is booked whether the posted rate or the contract rate will be used in calcualating the prepayment penalty. Waiting until “prepayment time” is like looking at the wrong end of a horse.

  15. WM, can you speak to the amount of the re-investment fee? Seems like TD is saying: Yes we use contract rate for our 3 month penalties, but then we add a reinvestment fee that increases the penalty to the same amount as though we were using posted rates.
    Its a crafty shell game, and I am a little surprised that more lenders don’t do this…

  16. Slightly different scenario…We have another 3 years left in a 5 year variable mortgage with CIBC. With the ability to make lump sum payments, it looks like we have the ability to pay off our mortgage sometime next year. Is it better to pay it off early or lower our payments to extend it to term?

  17. So I just pulled a clients registered charge for a 5yr Variable at p- 0.75% (registered as a collateral charge) with RBC to see what “Interest rate” they were referring to in there disclosure statement mentioned above… and they are correct they are not using the posted rate… BUT HERE IS THE KICKER… the rate is registered as Prime+7% not at Prime- .75%!!
    Am i reading that right??

  18. don’t forget to make full use of the typical 20% no-fee prepayment BEFORE calculating the penalty. Therefore the calculation is 0.8*balance*(rate)(0.25)

  19. Wow! That’s a real eye-opener. If I had ever read in a mortgage contract that the 3 months interest penalty was based on a rate different from the contract rate, I’m sure I would have stormed out of the bank branch. I checked all the mortgage contracts I’ve ever had and none specified what interest rate applied to the 3-month penalty. I always assumed it was the contract rate.

  20. I am wondering if ING charges you a penalty if you pay off your 5 year variable mortgage in 4 years by using the annual 25% over payment allowance. If you coupled that with increasing your payment by the allowed 25% increase annually you’d pay off in even less. Does anyone have experience with this type of situation with ING?

  21. Island Advisor,
    The prime+7% is the maximum that RBC could request if the mortgage goes into or is about to go into default and judgement. This type of ceiling is on all collateral charges from different banks in their documentation.

  22. Mike,
    The IRD was charged because the clause reads “the greater of IRD or 3 month interest…” (I’m paraphrasing).
    I thought this article was about 3 month interest penalties…lol.

  23. Sorry Arby,
    If you re-read the RBC disclosure that was posted by the earlier poster “specialist” you would see that it states that the definition of “interest rate” not as the Contract rate or rate you pay… but the rate on the registered charge. The rate of RBC’s registered charge is Prime+7% as mentioned on my earlier post.
    I am not saying that the 3 month RBC penalty is at 10% but rather the RBC disclosure statement does not specifically say anywhere on it that the 3 month interest penalty is calcualted based on the “CONTRACT RATE”. And clients should get that in writing from RBC if there registered charge is being registered at 10%(P+7%) to protect them from a surprise later!

  24. Island,
    You have to review the entire legal package together, including the Homeline plan agreement, the registration and the Standard Charge Terms. You can’t pick out one phrase and take it out of context and then make uninformed comment.
    In the document you refer to that was posted in an earlier post, Page 4, item 1, subsection b says “(i) 3 months interest on the amount prepaid at the Interest rate, or…”, now if you refer back to Page 2, Section 3, item 3.1 defines interest rate, which is the rate you promise to pay set out in the Registered Mortgage (aka contract Rate). It isn’t being registerd at prime+7%.
    The banks reserves the right if circumstances arise, such as default and judgement(foreclosure) to call the loan upon demand at a rate up to p +7%. This type of clause is in all banks and lenders legal packages, so it’s not exclusive to RBC. I’ve checked on this,as I have never seen it applied, and it is solely if the loan is called in for default as I stated earlier. Clients sign these docs in duplicate, and they do receive copies of all of the documents,at time of signing, as directed by law with reference to everything I have explained to you.
    I have in my hand 2 documents. One is the Homeline plan agreement, which For a fixed rate mortgage segment, the prepayment charge is the greater of (i) 3 months interest at the mortgage Loan rate; or (ii) interest for the remainder of the term of the mortgage loan on the amount prepaid, calculated using the “interest rate differential”… Then later in the document it shows how the calculations are done in simple math, with examples, for both methods.

  25. Are these prepayment allowances not calcualted on 25% of the prinicple balance each year?
    Year 1 $500K * 75% = $375K
    Year 2 $375K * 75% = $281K
    Year 3 $281K * 75% = $211K
    Year 4 $211K * 75% = $158K
    Year 5 $128K * 75% = $96K
    (Of course your monthly prinicple payaments would factor in, but isn’t this how it typically works? For the accountants, a declining balance calculation)

  26. Hey Jim,
    I haven’t seen any list of posted rates by lender. We’re starting to track them on RateHub so we can provide accurate penalty calculations. To supplement we’ve used bank of Canada average posted.
    Have a look at the calculator:
    We need to update with Rob’s great catch for lenders who use posted variable rates for 3 months interest.

  27. Several lenders are adding reinvestment fees to the mortgage agreement. This has been happening recently with the discounted low rates offered by lenders. It usually applies if a client does a refinance before the term is up. It is usually waived if the house is sold during the term and is at arm’s length. A rough calculation for 1 lender is .25% x outstanding balance x # years left. If you were to refinance in the second year it would be multiplied by 4 for the year factor

  28. You say : “You have to review the entire legal package together…”
    Here’s one clause RBC has in my contract :
    At any time we can charge a fee, change a fee or add a new fee without notice to you.
    So that’s one of the indications how “clear cut” are RBC penalties in their contracts.

  29. Another one of “everyone” I mentioned not please of RBC penalty amounts.
    Just to mention here, using the “discount” they give you in calculation you are always paying IRD penalty with them, very smart legal way to charge more if you decide to change.
    I want to be clear here – banks go in contracts too and they need to assure they don’t loose money when we break mortgage terms, but that RBC charged me was almost twice over what would have assured they have no loss of me changing terms (while staying with them).
    And one line about your constant reminders what this article is about – It is about awareness in my view :) Not all penalties are clear cut, especially with RBC (my experience)

  30. John, congrats, you found a clause that almost all of the big 6 banks have in their disclosures. Not only applicable to RBC, but probably to the institution you bank with as well. I never said they were clear cut, but I did say the answers to the questions being posed were clearly stated within the agreements and registrations.

  31. Do all lenders automatically deduct your 10-20-25% bulk yearly payment before calculating the penalty, or do you have to ask for it ahead of time?
    or, maybe the question should be, what lenders Don’t automatically deduct the % pmt

  32. Hi Munch, Most lenders don’t automatically apply your remaining prepayment privileges before calculating your penalty. Some do if you ask. Most that do expect you to keep your mortgage with them. There are exceptions though.

  33. Are you saying credit unions don’t have these types of clauses? What about trust/private lenders? How about this. A lender may do as it pleases as long as you sign and agree to borrow the moola. Quit complaining, suck it up & pay up little Jimmy.

  34. ING will allow prepayments to be made prior to penalty calculation. ING uses a simple 3 months interest penalty to break a VRM. I would really like to know who else charges a reinvestment fee? Rob, would love to know what you know on the subject. Excellent article as always.

  35. There is always a way to save on your mortgage rate, all it requires is a bit of commitment to your refinancing process and a proper mortgage broker.

  36. John is correct, it’s 25% of the original balance. So if you had a 100k mortgage and you paid this 25% every year you would be paid off in 3 years +1 day to get you into the next overpayment cycle. I’m wondering if ING will then charge you a penalty for paying off your 5 yr vrm early using their early payment tools.

  37. Alyssa,
    That is a great tool. Within a few years, it will be exactly what I am looking for.
    Of course we always tell clients that these are estimates, however the suprise of having a IRD charge more then double the estimate, does not always go over well.
    Great job. Thanks

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