BC Sunshine Coast real estate by Menno at Royal lePage Real estate on the BC Sunshine Coast

There are many kinds of mortgage features we could talk about right here: portability, pre-payment privileges, assumability, skip-a-payment options and so on.  Most mortgage contracts include a number of these, basically for your benefit.

In the world of mortgage money, we tend to forget about anything but the best rate. The mortgage features usually only come into play when it's too late: after the fact.

Do you know what features and what mortgage rights you have OR which features you should want? Some mortgage contracts are very outspoken about the “features”; others don’t talk much about them.

A good one to first look at is the portability clause, most mortgages have one of those. this means that when you move, you can take the mortgage loan with you. Sounds easy and straightforward but there’s (of course) a bit more to it. In reality, you will not take your mortgage off one property and put it on another. You will actually cancel the one mortgage and apply for another. If you do that within the parameters set by your financial institution, you may avoid the pre-payment penalty on the mortgage you are cancelling. You may also take over the interest rate on the remaining mortgage term; a feature that can be worth money when market rates have been going up.

Mortgage money (usually) comes from the bank ... obviously. But where does the bank obtain its money and how do they pay for that money?

IN THE LIFE OF A MORTGAGE LOAN

A mortgage, these days, runs for 25 years when first written (there are some exceptions to this: shorter or longer. Most mortgages are terminated well before they run out. How does that go and what does it entail?

When you actually, loyally pay your regular mortgage payments, it’ll take the full 25 to pay it off in full. In the end, the loan is paid and the house is owned free and clear. And that’s it! Early termination of a mortgage can occur for many reasons – a common one being a move. Even if you “port” your mortgage (take it “with” you), it’s still a new mortgage. Some people terminate their mortgage because they see a better deal somewhere else, at another financial institution – or even at the same financial institution. Other situations come up with major life changes: family matters or financial developments.

Another form of early termination may occur when borrowers decide to speed up their payment schedule. Virtually all banks permit extra payments to go against the mortgage loan without any pre-payment penalties. For instance, one could increase the monthly payment by 15% and this increase would be booked entirely against the loan. Also, most lenders allow an annual lump-sum payment, which is a situation that can come in handy when you had a particularly good year, had some windfall income or saved up some cash through sheer frugality. All that cash comes off the “end” of that mortgage. It has the effect of shortening the duration of the mortgage loan so that it gets paid off, well before its final installment date. If all that’s done within the pre-payment schedule provided for in the loan, there are no penalties. It’ll be cash for cash – a beneficial situation to be taken advantage of, when possible.

Banks charge penalty fees because it says so in the mortgage contract; the one you signed. There are, however, legal ways to avoid this expense.

PENALTY FEES TO BE AVOIDED

When you (suddenly) break a closed mortgage before maturity, you will probably pay a pre-payment penalty. The amount varies from lender to lender but is always dependent on the amount of the outstanding loan. Since it’s free (no penalties) to first make a regular pre-payment, this could be a smart way to reduce the final mortgage balance. Doing it this way, you pay less of a final discharge-pre-payment penalty.

Lenders have different policies on how close to the payout date you can make a pre-payment. Some lenders, for example, won’t allow pre-payments to be made within 30 days of the date of full discharge (the date you pay off your mortgage in full).

This smart strategy can save you Hundreds if not Thousands in pre-payment penalties by just taking advantage of the regular pre-payment privileges that you already have, by contract.

You're not the only one who would hate to have to pay mortgage penalty fees. The origin of the fees can be explained, to a point.

PENALTIES HAVE A REASON

Many people are offended by the thought of pre-payment penalties. This isn’t entirely fair, because they ARE part of the mortgage loan contract. Banks match the money they give out on a mortgage loan with incoming funds, for instance bond notes. For instance, a prudent banker may match the five-year mortgage portfolio against five-year bonds; they match three-year mortgage money against three-year bonds … and so on. Obviously, when a mortgage loan holder happily brings back their money to the bank, the banker won’t be able to instantly cancel the bonds. They have to place the funds elsewhere. It involves a lot of work, arrangements and some potential financial damage. Pre-payment penalties are intended to compensate for that.

There are markets where pre-payment penalties are not permitted by law (Australia, France and several other jurisdictions with certain limitations). The banks will then search for some form of other compensation. It’s obvious that a slight interest surcharge “cushion” for every borrower is a likely choice. The house always wins!

It all costs money, whatever you do at the bank. Consumer organisations are upset that mortgage penalties are unclear and hard to understand in how they get calculated.

HOW TO CALCULATE HOW MUCH YOU GRACIOUSLY NEED TO PAY UP

What amount of pre-payment penalty you will pay can be a complicated calculation. Some banks charge an interest rate differential – others a number of months’ interest fee. It all depends on a number of factors. When the issue is about to come up, it’s prudent to check with your bank to see how the pre-payment penalty is going to affect you and what instruments there are to keep that penalty as modest as possible. Do note, however, that pre-payment advice received today may be different tomorrow. Not only will your mortgage have a shorter remaining life after a while, other financial conditions or situations might also change in the meanwhile. This all can make quite a bit of difference even over fairly short time spans.

Needless to say that if you need advice on your mortgage loan that you should be talking to a mortgage specialist(banker, broker, etc). This web page provides general information that may not apply to your specific situation.

This vague topic of mortgage wisdom becomes less complicated when you simply know more about it - that way there will be less surprises later.

MORE information about money and mortgage topics in the following blog articles:

The 80% rule to watch: http://www.mennorealty.ca/Blog.php/80-or-81percent

The effect of lower rates: http://www.mennorealty.ca/Blog.php/buy-more-lowrates

Trouble with mortgages? http://www.menno.ca/?p=19338

About refinance and renewal: http://www.mennorealty.ca/Blog.php/renewal-1

An average Canadian mortgage is worth about $151,000: http://www.menno.ca/?p=19433

The mortgage income test: http://www.mennorealty.ca/Blog.php/proof-of-income