2020-09-10 | 08:14:06

 

***this is an update of an article I wrote several years ago that is now more relevant than ever due to the current interest rate environment. If you only have time to read a bit of it – skip down to the paragraph called ‘UNFAIR PENALTIES’.

 

MORE LENDERS = MORE OPTIONS

Canada is home to over 100 institutions that lend on mortgages. Many are well known with retail branches throughout the country, but the majority are smaller credit unions, ‘monoline’ mortgage companies (that only do mortgages), and trust companies. One of the most common comments I get when arranging a mortgage is ‘I’ve never heard of (insert bank name here)’. There are very good reasons for this that I will discuss below.

My clients know that over the years, I have arranged mortgages through quite a few different banks. My prime objective when reviewing an application is always ‘which lender is the best fit for the client’ – taking into account: interest rate (of course), pre-payment features, portability clauses, and repayment penalties to name a few. Beware the broker whose disclosure document shows that they have only used one or two lenders – they might be more worried about their compensation (via volume bonuses) than looking out for you.

WHAT DO THE BIG BANKS DO WELL?

The BIG BANKS – we all know who they are – do two things very, very well. First – they make money. All banks have a primary objective and that is to make money for their shareholders. This is of paramount importance when dealing with the banks directly. Always remember that a bank’s first goal is to make as much money off of you as possible. Any bank employee that gives every one of their clients the absolute best deal on a product, whether it is a car loan, investment vehicle, bank account, or mortgage is not going to be a bank employee for very long. This is the most significant difference between dealing with a bank employee and dealing with a broker when sourcing out a mortgage. A bank employee will look to maximize their employer’s profit – it could be through offering a higher rate than their lowest, or recommending a product which makes the bank more money than another product that might be better suited for a client. A good mortgage broker will always make sure you are in the right product, and is motivated to get you the lowest possible rate on that product (or we don’t get paid).

Secondly, the BIG BANKS are very good at marketing and advertising. Canadians are conditioned to trust that their bank is looking out for their best interests and are there to help them the best they can. Watch TV, read a magazine, or listen to the radio – the BIG BANKS spend more money on advertising than almost any other industry. (Automotive and Pharmaceuticals are the two that spend more). Take a moment and think about where their advertising budget comes from. I’m not saying that mortgage brokers don’t try to make money too – but there is not a significant difference in our compensation from lender to lender and product to product so our motivation really is to get you the best possible rate and features with your mortgage.

 IS THIS BANK SAFE?

Also important to note when asking the ‘I’ve never heard of (insert bank name here)’ question is that any institutional lender in Canada has to go through an extensive process before the government will allow them to lend money and our banking laws do not let any bank lend out more money than they have. There are no fly-by-night companies operating in Canada. Banks may be bought and sold as in any other industry (eg: ING was purchased by Scotia Bank a few years ago, HSBC Canada has been sale for years), but IF your mortgage lender was sold to another company, the new owner CANNOT make any changes to your mortgage contract. Your mortgage is an asset to your bank and therefore there is no risk to you if your lender is purchased by another company. Many of the banks I use do not have retail locations and do not spend a lot of money on advertising --- mainly as a result of being motivated to offer the best possible rates. As mentioned above – advertising budgets have to come from operating revenue in one form or another.

 UNFAIR PENALTIES

This brings me to my pet peeve with the BIG BANKS. Early repayment penalties. Mortgage lenders in Canada are allowed to charge the higher of two calculations when someone pays out a fixed rate mortgage early – which happens most often when someone sells their property or attempts to refinance their mortgage to secure a lower rate. The first calculation is simple – a 3 month interest penalty: you take the mortgage balance and multiply by the rate and then divide by four. For example – a $300,000 mortgage at 3.19% would have a penalty of:

 300,000 x 3.19% = 10,176.10 divided by 4 = $2,544.02.

This is fair. The penalty is there to compensate the bank for their losses should you pay out your mortgage early. No one is arguing this point. Where it becomes unfair is when the bank applies its own special ‘Interest Rate Differential’ penalty (IRD) calculation. This applies when the current rates are lower than the rate on your mortgage contract. Here is what one of the BIG BANKS has posted on their website with regards to IRD:

“The IRD amount is calculated on the amount being prepaid using an interest rate equal to the difference between your existing mortgage interest rate and the interest rate that we can now charge when re-lending the funds for the remaining term of the mortgage.”

Again – this sounds fair. We can’t expect any business to willingly accept that they should lose money. But let’s take a closer look at how the BIG BANKS determine the IRD.

 For the example above, let’s assume that the client had 2 years left on that mortgage and the best 2 year rate available at this particular BIG BANK is 2.69%. Any reasonable person would then look at the above website quote and would come up with the following calculation:

300,000 x (3.19 – 2.69 = .50% ‘interest rate differential’) x 2 (as there are 2 years left on the term). Therefore the IRD penalty should be $3,000. In real dollar terms, this is what the bank lost by someone paying off their $300,000 mortgage, and then relending that money to someone else for 2 years. Math does not lie. Now let’s assume rates had gone up since you took out your mortgage, and the bank was now able to lend that money out at a much higher rate. Would the bank give you an interest rate differential reward for allowing them to increase their profit on that mortgage amount. No, no they would not.

BUT ALL of the BIG BANKS throw a monkey wrench into this calculation. They all factor in the discount that you received when you originally took out the mortgage. If the BIG BANK ‘posted’5 year rate was 5.19% when you took out the mortgage, in this example you received a ‘discount’ of 2% on their 5 year rate. If this BIG BANK has a posted 2 year rate today of 3.04%, here is where it gets extremely unfair. Instead of an IRD penalty of $3,000, the calculation now looks like this:

$300,000 x 3.19 – (3.04% - the current 2 year posted rate minus 2% - the discount received off of the 5 year rate = 1.04% - therefore the ‘difference’ between ‘your rate’ and the ‘new rate’ is 2.04%) x 2 years = 300,000 x 2.04% x 2 years = $12,240!!!

When you read the quote off the BIG BANK website, it is contradictory to their calculation. JUST TRY AND GET THE BIG BANK TO GIVE YOU A MORTGAGE WITH A FIXED RATE FOR 2 YEARS AT 1.04%!!! It wouldn’t happen. This client is then not only compensating the bank for their loss, but is paying more than FOUR TIMES that amount. (Please refer back to above where I wrote that the BIG BANKS are very good at making money).

There have been a couple of class action lawsuits that disputed these penalties, but the BIG BANKS still charge them. Now you know why the BIG BANKS have these ridiculous ‘posted rates’. They almost never charge the posted rate, and it sounds great when the bank representative says ‘I’m giving you a 2% discount off of our posted rates’, but there is a reason to continue to put these artificially high rates on their websites – profit.

 NOT ALL PENALTIES ARE CREATED EQUAL

So to tie it all in......One of the main reasons I may have provided my clients with a mortgage approval from MCC Centric, First National Financial, RMG, CMLS, etc is their reasonable penalty calculation. These lenders do not play the ‘posted rate’ game. They advertise market rates – you can go to any of their websites and determine what your interest rate differential penalty would be. All banks are required now to put a penalty calculator on their website....but it is clear that Canadians who go directly to a BIG BANK don’t do this simple comparison when shopping for a mortgage. A good mortgage broker will do this for you. Out of the banks I just listed above, and using the same example, the highest IRD penalty that would be charged is $3,750 as opposed to the $12,000+ penalty charged by the BIG BANKS.

 STUFF HAPPENS

Of course, no one that takes a 5 year fixed rate mortgage expects that they will pay it out before the end of the term. If you tell me that that is the plan, then I wouldn’t put you in a 5 year fixed rate. But sometimes life gets in the way. People get transferred at work, people lose their jobs or marriages break up and a property needs to be sold, or as is the case now, interest rates are historically low and clients want to save interest costs

So....sorry for the long rant, but I felt it important enough to give you a detailed description of how these penalties work, and also why the BIG BANKS are so good at what they are intended to do ---- make money for their shareholders.

Stay safe and healthy and as always, please feel free to call or email me anytime if you have any questions regarding a mortgage. I also have $150 Keg Restaurant Gift Certificates to send out to anyone that refers a new client who arranges their mortgage with me.

Thanks,...Patrick