When it comes to complaints about banking products, mortgages are second only to credit cards.
That’s according to the banking Ombudsman’s (OBSI’s) recently released annual report, which lists three of the most common grievances from mortgage customers.
“We are seeing a lot of complaints related to mortgages…” Brigitte Boutin, Deputy Ombudsman, Banking Services said in the report. Those complaints revolve mainly around mortgages prepayment penalties and pre-approvals, but it seems that mortgage portability has also “become a bigger issue.”
The Big One: Penalties
The Ombudsman sees a constant stream of borrowers protesting their bank’s prepayment charges. Those complaints are usually dismissed after an appropriate investigation, with a finding that the bank did nothing wrong.
“When investigating mortgage prepayment penalty cases, we examine the signed agreements between the client and the bank and review the accuracy of the penalty calculation.
We also look at the manner in which the client was informed of the penalty before they proceeded with the mortgage transfer.”
A common claim by customers is that they were not told how the bank calculates its mortgage prepayment charges. Frequently the problem stems from the comparison rate changing before the borrower can pay off the mortgage.
The comparison rate is the rate the bank compares to your rate, to judge the interest rate differential, or IRD (i.e., determine the difference between your rate and the rate the bank can supposedly lend at today, for your remaining term).
Timing is key. If you’re 2.5 years from maturity, for example, the comparison rate might be the three-year fixed rate (say 3.04%). If you’re 2.49 years from maturity—one day closer—the comparison rate might be the two-year fixed rate (say 2.59%). The actual comparison rate used can increase the IRD and lead to unexpectedly high penalties.
In any case, with all the prepayment regulations nowadays, lack of disclosure is getting harder to argue. In one case on its website, OBSI found that “the fact that the client was not told all the specifics of the calculation did not change the fact that he had the necessary information to make an informed decision.” OBSI ruled in favour of the bank in that instance.
“People sometimes take for granted that their mortgage is portable before selling their home,” Boutin said in the report. “It’s interesting – we’ve seen cases where the bank refused portability because the borrower’s financial situation no longer met the bank’s lending criteria. However, the client was able to get approved somewhere else right away.”
She raises a key point that all borrowers should be aware of. Given that the property is the lender’s security, you can’t move your mortgage to a different home without the lender’s consent.
Porting requires a whole new application process, documentation and approval. Failing that approval, people with closed mortgages have little choice. They can either not move or they can pay the lender’s penalty (potentially thousands of dollars) to discharge the mortgage and find other financing.
Boutin adds: “A bank can refuse to transfer a mortgage from one property to another because the client’s situation has changed and we can’t force a bank to lend money when its lending criteria is not met.”
She advises: “…Read the terms in your mortgage agreement carefully. Check if there are certain criteria related to portability and check if you meet your lender’s criteria before deciding what to do.”
Common portability considerations include:
- the amount of time the lender gives you to port
- the rate the lender gives you if you “port and increase” (add more money to the mortgage)
- the lender’s policy on bridge loans (commonly needed when your new purchase closes before your sale)
- the type and location of property the lender will lend on, and
- the types of income the lender allows (e.g., key, for example, if you become self-employed and can’t prove income in the traditional manner)
“…We’ve seen an increased number of files relating to mortgage pre-approval,” Boutin notes. “Banks may not verify everything in detail when they pre-approve a mortgage. Then, when people go to finalize a mortgage, the bank will ask for more information and for supporting evidence of what was previously disclosed.”
“Sometimes that new information will lead the bank to change financing terms or refuse financing altogether. People can then get caught, especially if they removed the condition for financing on their offer to purchase a home.”
I’ve written about pre-approvals many times and continually hear cases where people thought they were unconditionally approved, but hadn’t even provided income and down payment documentation. Often it’s a matter of the mortgage adviser not clearly explaining that pre-approvals are rarely fully underwritten (including by the default insurer, when the down payment is less than 20%).
“A pre-approval document indicates certain conditions that need to be met,” adds Boutin. “Be careful that you’ve given the right information to your bank and that your documents match (emphasis ours) what you provided at the beginning of the mortgage process.”
You blatantly ignored the major effect of using the posted rate discount in banks calculating the penalty. Especially now, when every fixed rate has a discount of 2% or more, you’ll have lots of huge penalties in the next years. Pick a lender that does legit discount to discount, or go variable.
The government should standardize the IRD, they’ve gotten involved in every other aspect of the industry,
Hi Reed, This was a summary of the OBSI report which didn’t focus on the posted rate calculation. It’s indeed a concern but we’ve covered that topic in several other stories, all accessible using the search function.
It sounds like you’re not a fan of Scotia, TD or National Bank. If you don’t mind me asking, roughly what percentage of your business do you send to them combined? Do you refer any clients to the major banks at all?
Regarding standardizing penalties, the government won’t directly regulate mortgage indemnities as that would be akin to limiting banks’ interest and fees. Even if regulators did this, banks would make up for it by adding restrictions, other fees or higher rates. Consumers would be no further ahead. Instead, the government has chosen to regulate penalty disclosure.
Hi Rob, thanks for the reply.
I do lots of business with Scotia, they have some excellent products and the STEP is always a favorite of mine with them. A good portion of business goes there, and TD has always been great as well.
However for a normal fixed rate mortgage, in choosing a lender I think its important to pick a lender that will calculate the penalty fairly. It’s called an Interest Rate Differential, and should reflect the actual cost (loss) to the lender from losing the mortgage, based on the expected rate they can lend the money out for the remaining term. If you throw a posted rate discount (which is an arbitrary number, really), the only effect is to unduly penalize the client. So I would tend to prefer a lender that won’t unduly penalize the client, all else being equal.
Also, regarding standardizing, I would say that hidden fees in the form of windfall penalty profits is less preferable than an open and competitive marketplace. For the borrower, anyway.
Hi Reed, You hit the nail in that, given two near-equal fixed mortgages, the one with the less punitive penalty is generally preferable. Of course, mortgages are routinely unequal and the major banks have features and flexibility that many non-banks do not — which, I suspect, is why you do a lot of business with them. Additionally, when it comes to shorter-term fixed rates, the penalty difference can be less significant.
There also tends to be a lot of double-talk when it comes to prepayment charges. Some originators (I don’t mean you) rail against big bank penalties while simultaneously selling millions of dollars of big bank fixed rates. Penalties are best positioned as one factor — albeit an important factor — in determining mortgage suitability.
How do you have “huge” penalties if rates stay where they are or go up?
I also question your advice to go variable to avoid penalties. This is not an option for the majority of people who go fixed. People go fixed for more important reasons than the penalty.
The banks recently petitioned the government to force more borrowers into taking the 5yr fixed rate, by forcing qualification based on the posted rate for terms less than 5yrs fixed. The reason they did that is either to protect their clients’ interest if rates increase, or that the 5yr fixed term is the most profitable trade for them. You can decide which is the main reason.
Also, my advice was to go with a lender that calculates the penalty on the discount to discount rate, if you read my post again.
@Specialist: You can still have huge penalties even if rates go up or stay the same with posted rate IRD. The formula is based on the difference between posted rates. As long as the posted rate curve remains as it is (with a positive slope), you will get huge penalties.