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Painting a Picture of Penalties

Penalty-CalculationsA 1/10th percentage point rate discount on the average Canadian mortgage saves roughly $800 in interest over five years.

An unfavourable mortgage penalty (interest rate differential charge) on a fixed mortgage can cost the same borrower 2-5 times that amount, or more.

By and large, lenders with favourable penalty calculations do a poor job of highlighting their competitive advantage. But ATB Financial is one lender that does it right.

ATB is one of the best lenders at showing how a “fair penalty” works: Example 1, Example 2, Example 3

Its website juxtaposes:

A)  The penalty formula of a major bank:

(Contract rate – [Posted rate for remaining term – Discount from original mortgage]) x Principal outstanding x Remaining term

B)  A “fair penalty” formula:

(Contract rate – Posted rate for remaining term) x Principal outstanding x Remaining term

Note that “Posted rate” in this second formula refers to the actual everyday rate offered to consumers, as opposed to an artifically high posted rate.

Various lenders, including major banks and certain credit unions, use unfavourable penalty formulas.

Conversely, many lenders use a fair penalty calculation like ATB’s above. You just have to know where to find them. Any broker can name several such lenders. (We are also compiling a list of the biggest fair penalty lenders and will post it soon.)

Lenders with reasonable penalties could be well served to follow ATB’s lead and highlight this as a competitive edge on their website. By explaining and quantfying the potential savings, some borrowers are more open to paying a slight rate premium.

Mortgage-Calculations (2)A lender could even create a calculator comparing its penalty versus a major bank’s. The customer could enter his/her mortgage amount with some basic assumptions and the webpage would display a range of hypothetical savings (based on future rates). The potential savings could then be put in terms of an equivalent rate discount.

Despite the fact that a majority of 5-year borrowers renegotiate their mortgage before maturity, only a minority of people actually pay a penalty. Many sidestep penalties by porting their mortgage or doing a blend and increase. But those alternatives have pitfalls (you have to qualify with that lender, you may not get its best rates, and some lenders build a penalty into their blended rate).

Most people who pay penalties never expected that their circumstances would require it. That’s why it’s always helpful to understand (ahead of time) what a lender’s penalty calculation might mean to your bottom line.

Sidebar: ATB says that in the last 12 months, 9% of its 5-year fixed borrowers paid out their mortgage before the maturity date (some might come back under porting). Another 3% renegotiated or changed their mortgage contract, including refinancing and porting.

ATB notes that the numbers given above are fairly dynamic and depend on various factors pertaining to portfolio aging, the interest rate environment, time of year, economic conditions, property values, mortgage type (conventional vs. high ratio), social/demographic changes, etc. These could vary from time period to time period.

Rob McLister, CMT  (email)