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

When you arrive at your lawyer’s office on the day of closing and suddenly get presented with a 71-page mortgage contract, do you read it all and endeavour to negotiate the contract to your advantage or do you just sign it?

A mortgage contract, like any other contract, gives you something for something. The banks promises you money at a certain rate of return for a certain period of time.

In fact, about 100% of borrowers don’t read the mortgage contract. They just sign it and hope for the best. Why do we not read the contract? Because we are in a hurry to close the real estate deal and move into the house we desire. Even if we read the entire contract, we wouldn’t understand it because we’re not trained for that (law school, for instance). The exercise of signing the contract seems just pointless. Nevertheless, it’s there and we’ll be held to it – if and when.

It’s safe to say that mortgage contracts are impossible documents to read – particularly when you’re in a hurry to get your home purchase closed. This is why you need to know its contents well ahead of your official visit at the lawyer (notary). You need to – yet nobody does.

This is, in a nutshell, how you’ll sign away your life at the lawyer’s office because you will perceive the situation to be such that you have little other choice. The moving truck is on its way, utilities have been connected, a happy day is awaiting you. A new life, of sorts, is about to begin for you. The last thing you’ll want to do is hang up progress due to a legal document that you don’t understand.

The power of the mortgage contract also stipulates what you must do for a certain period of time - it's not easy or cheap to change the parameters of that agreement.

WHAT DID YOU JUST DO?

A mortgage, that’s when the bank “gives” you money to buy a house. All you need to do is pay the monthly instalments. Although this is mostly true, a mortgage contract also stipulates just about all the eventualities one could run into over the life of a mortgage. The complexity of this contract may lead to problems later.

A serious concern is created by the early termination charges of the mortgage. Most people don’t even consider these at the moment of inception, just like you wouldn’t immediately consider a divorce when you’re getting married. Ending the mortgage is the last thing on your mind when you’re just starting one. Yet, most mortgages run for a much shorter time than their anticipated term (often five years). Banks know this and will charge you severe pre-payment penalties (if indeed you opt out of the contract before its due date, for whatever reason).

Only if you are a skilled speed reader and versed in the law, you can extract from the mortgage documents the method they are going to use to calculate a mortgage penalty later, when the time comes.

Your mortgage contract stipulates what will happen if you break the arrangement at one point, during the course of the agreement.

THE COST OF BREAKING THE TERM

Pre-payment penalties are charged by the bank when you terminate a mortgage contract before the mortgage-due-date. These penalty charges are calculated differently at various banks, yet usually poorly explained to new borrowers. Since many people end up being faced with pre-payment charges, it’s actually a topic worth your attention. This is particularly true, since the amounts in question run into the Thousands of Dollars – could even be Tens of Thousands.

Here’s the problem: the first time ever you’ll see your “mortgage documents” is usually at the lawyer’s office. What are you going to do, hold up the time-sensitive closing to “read those documents” or are you just going to be done with it and sign them graciously? After all, they are standard papers or so you might think. It’s not that you can do anything about them. It’s “take it or leave it”. If you were to not agree with them, you have no negotiating power because the bank dictates and you are supposed to just agree.

If you dare to not agree, you could try another bank. In that case, you’d have to start the application protocol all anew. As a trouble-maker, you may not be so welcome at the bank. Are you really going to do this the day before closing? Probably not.

Since you signed the mortgage contract at the onset, there's really no way to break it unilaterally, unless you pay the stipulated mortgage penalty.

YOU CAN’T WIN THIS ONE

Since you can’t really win this one, you just sign. You really have no choice and you hope that the contract must be quite reasonable because it is, after all, a standard contract that’s used coast-to-coast in our wonderful country. Well, let’s quickly see how reasonable it might not be. Of course you have the freedom to just “not sign” but there will be consequences. For starters, the deal won’t close. Next up, the seller would be quite upset that you’re not closing. Who knows, you’d lose your deposit or end up in court over this – not with the bank but with the seller. So much for your freedom to “not sign” the last-minute mortgage documents!

The mortgage contract will come to bite you later, for instance if you need to sell the property for whatever reason. You’ll have to pay a penalty to terminate a mortgage early. The penalty calculation has landed more than one consumer in more trouble they had not anticipated.

Some banks now offer handy mortgage penalty calculators. Of course, most people will only use these when they need them. At other times, the penalties remain a mystery.

Some people think that the mortgage penalty will be less when you're more advanced into the term; even that isn't always true.

CALCULATING THAT PENALTY

Usually, if you want to break your mortgage, you have to pay three months’ interest OR an interest rate differential (IRD). The calculated amount is supposed to reflect how much money your financial institution will lose by you backing out of your contract. There is some logic behind the penalty calculation. In order to get the “best possible mortgage rate”, you have agreed to sign up for a certain period of time. It’s something for something (quid pro quo). If you take away one part of the deal, you also have to look at the other part of the deal.

The problem with some lenders is how to calculate the interest rate differential. Some banks use vague-enough language in contracts that allows them to calculate the IRD as they see fit, leaving the consumer with no way to challenge that penalty. At issue is that some banks like to charge the penalty in so-called present-day Dollars. It’s hard, if not impossible, to spell out in a contract what, exactly, this would mean.

A quick look at some of the major banks’ prepayment calculators is eye-opening:

• Bank of Montreal
• CIBC
• HSBC
• ING Direct
• Laurentian Bank
• National Bank of Canada
• Manulife Bank
• Royal Bank
• Scotiabank
• TD Canada Trust

These calculators were mandated by a federal government initiative from the Department of Finance – as a form of consumer protection (after the fact). The penalties vary wildly if you enter the same kind of information in various calculators.

A mortgage contract usually contains "privileges" that you can apply to reduce the mortgage penalty or even eliminate it entirely.

WAYS AROUND PRE-PAYMENT PENALTIES

When a financial institution charges you a prepayment penalty, you have no choice but to pay it. If you don’t pay it, the bank won’t discharge the mortgage from the property. You are stuck. You’re left with paying the penalty and seeking redress afterwards – almost impossible since you signed that contract in the first place. If that contract was unfair to you, well that’s too bad. It’s too late to complain about it afterwards. Really very few people will endeavour to challenge the validity of the contract after the fact – it would also cost a lot of time, stress, money and endurance.

The prepayment penalties are often huge amounts. Generally speaking, the longer the remaining term might be, the greater the amount of the remaining fees will be. On some loans, the penalty can be as much as 10% of the original mortgage amount.

There aren’t many lawyers that can read mortgage contracts and get a clear sense of all the possible scenarios one might run into when terminating a mortgage loan. It’s just too complicated to understand. Even if we say that people should read the entire contract (which is quite unrealistic, certainly given the short time-frames surrounding closing date), then it’s safe to say that they won’t quite understand the implications. Even if they were to understand, there’s nothing they can do about them. It’s a one-way contract.

In Canada, we have very low mortgage rates - much lower than in many other countries. But mortgage penalties are quite high here.

POOR CANADIAN CONSUMERS

Consumers in Canada normally end up on the short end of mortgage disputes because banks are strong and have virtually unlimited resources to assert their position. It’s time that banks come clean and begin to understand that they can only maintain their stranglehold on the general population because the government lets them. It would be better to voluntarily fix excessive mortgage contracts as opposed to having the government dictate how to do it (like in many other countries).

Assuming we can all be reasonable and not too greedy, we can make this work just fine. When you break a contract, there could be a penalty. We just need to simply know when and how much, ahead of time. There would also be a benefit in stating this more clearly before entering into the mortgage contract.

If you're well informed about mortgages and mortgage roles, there is less of a chance that you might be stung with mortgage penalties.

MORE about (borrowing) money and the politics of money in the following blog articles:

Financial markets and lowest rates: http://www.mennorealty.ca/Blog.php/buy-more-lowrates

Difficult to get mortgage money: http://www.mennorealty.ca/Blog.php/harder-mortgage

Paying less mortgage interest: http://www.menno.ca/?p=19982

Fixed-rate mortgages, popular again: http://www.mennorealty.ca/Blog.php/fixed-rate-territory

The valuation of your mortgage: http://www.menno.ca/?p=20035

Mortgage contract interest rates: http://www.mennorealty.ca/Blog.php/record-low-1