Having been the recipient of some outrageous mortgage payout penalties in the past I have a rather jaded opinion of this practice that banks are using to provide themselves with a tidy little cash windfall. I’ve previously written about mortgage payouts, but a new story out of Vancouver prompted me to revisit it.
You see, there was a couple in Vancouver who after having their second child found their condo they purchased with a mortgage of over $400,000 was becoming unaffordable to them, due to being reduced to a single income. Being prudent, they decided it was best to sell, take a loss if they had to and then find something they could afford. It turns out doing what initially appeared to be the smart tact ended up sticking them with a $30,000 mortgage payout penalty on their mortgage.
The lender in this case, Scotia Bank, was kind enough to make a goodwill gesture and they reduced the penalty by $5,000, so I am sure the homeowner is ecstatic. Especially since they originally told him, the fee would only be around $17,000.
So what triggered a $13,000 increase in his payout penalty? It’s simple he waited and didn’t sell immediately. By waiting and having less time remaining on the mortgage, you would normally expect this to result in a lower payout charge. Less time left on the mortgage, less money the bank would miss out on, but there is a catch.
The problem for this individual is because he waited, and there was less time remaining on his mortgage, rather than calculate his payout penalty on the five year rate which his mortgage originally was based on; they now used a much lower three year rate to calculate the mortgage rate differential. Does this sound wrong to anyone else?
It also helps explain why banks are currently making billion dollar profits. They have the cash, so they are able to make the rules and the rules change depending on the scenario. As I explained, I’m already a bit jaded with banks and lenders, so perhaps I’m reading too much into this, so I would love to hear your thoughts.
Now I’m not specifically picking on Scotia Bank in this case, they just happen to be the lender in this case. The practice itself is actually an industry standard practice across all mortgage contracts. The idea of these payout penalties is to allow banks to recoup their own costs of borrowing the money themselves. The problem is we never get to see these actual costs and determine whether it just creates a new profit center or is really a reasonable fee. We just have to pay out our fees and move forward.
Perhaps I’m looking at it wrong, but couldn’t the lender simply re-loan the money out again under a term that would fit the period they have the money on loan? Thus, they would continue to profit from the money and avoid their own payout penalties? Unfortunately though, I ‘m not a banker, just a small business person and an entrepreneur so I will likely never know if this practice would be possible and could help reduce these outrageous penalties.
You can find the more on this story here Mortgage Fee Doubles
I’m going to sound like an ass, but people have to be planning for the future. If they were expecting to be reduced to a single income, they should have planned for it. ie not taken a $400,000 mortgage. Renting is not such a bad thing. If you can’t afford it, and think you might have to break your mortgage, acknowledge it. I feel for the guy, but the penalty is specifically written in the mortgage contract . Read the mortgage document and make sure you understand everything! Banks, if given the opportunity, will screw you. So do your homework. Worst case, switch to a variable mortgage where the penalty is a LOT less.
My two cents… which I am sure 99% of people will disagree with.
I agree with Trevor but the clients also had other options to avoid these penalties if they knew this was coming and wanted to play hardball with the lender … they could have escaped the entire penalty with a key strategy. Or they could have also ported their mortgage and only paid a penalty on the amount that was bought down over and above their regular annual allowance and moved into something for less with the same reduced mortgage.
You definitely need to pre-plan as Trevor mentioned and if you are going to lock in to a contracted rate and want to get out of it, the penalty will either be 3 months interest or if the lender cannot re-lend that money for the same or more, you will have to pay out the difference for the remainder of the term, whichever is greater: i.e. if they borrowed at 5.50% and the current market only allows them to re-lend at 3.89%, the bank will want the 1.61% difference on the balance for the remainder of the term for sure. I would if I was lending my money too. Variable rates don’t work this way so a 3 month interest penalty is generally the max, hence why I prefer them over fixed rates myself personally.
This is another example of all the more reason to work with a Professional Mortgage Broker and a seasoned Real Estate Agent who would have likely caught this before the clients were surprised at the lawyers office.
I agree with most of your comments Trevor, but my issue is with the banks using this as a cash cow. This is universal in all the mortgage documents, so it really isn’t a surprise, but at what point is a $30k penalty excessive? They are a bank, they lend money, their argument here is they borrowed the money and have to pay a penalty as well.
First I doubt they are paying anywhere close to $30k for a penalty and second, why don’t they loan it out again to someone else for a shorter period and then not have to deal with their internal payout? Sure penalize for breaking the contract, but make it reasonable, not excessive and don’t change the rules. In this case they were penalizing him based on a 3 year rate when he had a 5 year rate. Shouldn’t they have based their loss on 5 years then as well, not the shortened more costly 3 year?
True Trevor, they have several other options, but the banks typically neglect to mention this as it costs them profit. In this case porting wasn’t an option, since they couldn’t afford the payments, but they still had many other options.
As for the lender re-lending the money, it is very possible it was relent, and then they double dipped, but you can be sure they won’t refund anyone after the fact. I have paid out dozens of mortgages over the years and not once did they come back and say oooops, we owe you $5,000 because we were able to loan your mortgage funds out again.
As you mentioned having an agent and a broker who understands these options and the bank rules would have helped them significantly.
Bill
I’ve never heard of a Mortgage payout being larger at the end than at the beginning. What kind of a mortgage product did they have? I’d like to know so I can be sure to avoid such in the future. This sounds very wrong. It sounds criminal.
Hi Theode,
Just to clarify, what happened is the fellow had a 5 year mortgage term, but when he had to do the payout the lender based the payout on the much lower 3 year term which is what he had remaining. Since the interest rate was lower, he was penalized more. So even though technically there was less outstanding the bank was able to charge more. The lesson is if you are selling and breaking the mortgage, be aware of the time frame left and when it may trigger a new interest rate.
Bill
Wow, talk about making money – I though insurance agents were the kings of this!
My husband often opines about the money the banks (in Canada) make off the backs of customers. He is from the states and has been surprised by the fees and extra costs he has come across in all of his banking with various companies and numerous banks.
However, I know there are two sides to the coin, and it is unfortunate that people decide to become owners without checking out everything they are signing, and without planning for the future.