Class Action Lawsuit vs. Big Banks for Mortgage Pre Payment Penalties

[MillerTime GFG]

Interesting to see how this develops. Most people don't know how the big banks calculate their pre payment penalties on mortgages, but they're insanely punitive. The "discounted rate" they give you that makes you feel all warm and fuzzy is just so they can increase profits and retention, as your penalty will be based on their posted rate - not your discounted rate.

http://montrealgazette.com/business/...ayment-charges

[mrkajz44]

Hard to think this will actually go anywhere. I'm fairly confident that the prepayment penalty is clearly included in the contract when signed, regardless of how "incomprehensible" the calculation may be. I looked into it once and it really wasn't that confusing - they compare your rate to the rate associated with the number of years you want to cut your mortgage short.

The idea that the bank is ripping you off is also wrong. This protects banks from people signing longer term fixed rate mortgages (5+ years) and then cancelling 2 years in because interest rates fall. The consumer is protected for rates rising by getting a fixed rate. The bank is protected for falling rates by the prepayment penalty. Both sides are just protecting their interests, which makes sense in a long term contract.

[troutman]

Disclosure statements are clear in showing how much interest you will pay over the term of your mortgage. The statements could be clearer on how prepayment penalties are calculated, with examples.

Both clients described the calculations behind the penalties they paid as incomprehensible. The first, who decided to sell her property after making two years of payments, had to pay an “IRD” charge of $12,648 to the Toronto-Dominion Bank, instead of the prepayment penalty calculated on three months of interest, which would have been $2,247.

A second client, dealing with CIBC, was ordered to pay $29,340 instead of the three-month interest penalty of $5,788.

“The difference is objectively abusive, excessive and disproportionate,” the class-action application states.

Would these clients have entered into these mortgages if they knew how big these penalties could be?

Sometimes you can convince the bank to waive the penalty, if you get another product with them.

Sometimes the mortgage with the lowest interest rate, is not the best product for you.

[CaptainYooh]

Originally Posted by mrkajz44

...
The idea that the bank is ripping you off is also wrong. This protects banks from people signing longer term fixed rate mortgages (5+ years) and then cancelling 2 years in because interest rates fall. The consumer is protected for rates rising by getting a fixed rate. The bank is protected for falling rates by the prepayment penalty. Both sides are just protecting their interests, which makes sense in a long term contract.

Well, yes and no. Big banks "buy" consumer mortgages, then package and sell them to other financial institutions making money on spreads and fees.


In US - consumers get a 30-yr fixed rate mortgage on a house which can be paid out anytime without a penalty. So, pre-payment penalties are not a common necessary evil.

[troutman]

Alberta = Part 9, Cost of Credit Disclosure

http://www.qp.alberta.ca/documents/Acts/c26p3.pdf

[MillerTime GFG]

IMO the main issue with the big banks is not the IRD itself, as all lenders use that on fixed rate mortgages. The main issue is they use posted rates to calculate, not the contract rate. How many mortgage specialists at the bank are properly explaining this? Collateral mortgages could fall under the same.

[nfotiu]

Originally Posted by CaptainYooh

Well, yes and no. Big banks "buy" consumer mortgages, then package and sell them to other financial institutions making money on spreads and fees.


In US - consumers get a 30-yr fixed rate mortgage on a house which can be paid out anytime without a penalty. So, pre-payment penalties are not a common necessary evil.

It seems that in the US, the fees are all up front and a lot of the line items are pretty much made up and can vary from 0 to over $10,000, with lower interest loans usually having higher fees and points. So, re-financing only makes sense if you are going to save enough to cover those fees again. Basically, we pay our pre-payment penalty up front.

[bizaro86]

I think prepayment based on interest differential is fair and not that complicated. I think there might be a case for arguing the amount of the pre-payment privilege should be exempt from paying the fee.

As a bit of a public service announcement, if you're selling, it sometimes makes sense to pay off as much as you're allowed to as a one time payment first, even if you have to borrow the money short term from somewhere else.

[GGG]

I like how by using IRD as an acronym they make it sound scary.

Read your contract if it's anything like the rest of them the penalty is IRD or 3 months interest. This isn't even fine print on the back of a cellphone contract.

If you can't figure out what IRD is and how to calculate you probably should be hiring an expert to take care of this for you before entering into a half million dollar contract.

[Bend it like Bourgeois]

Is there a defence worse than ‘we’ve made it deliberately incomprehensible to you, so it’s your fault you didn’t take steps to comprehend’?

Even if there were a way for consumers to understand it, its a hugely inflated number that’s designed to screw their customers. I hope the banks and brokers take it on the chin.

[GGG]

Originally Posted by Bend it like Bourgeois

Is there a defence worse than ‘we’ve made it deliberately incomprehensible to you, so it’s your fault you didn’t take steps to comprehend’?

Even if there were a way for consumers to understand it, its a hugely inflated number that’s designed to screw their customers. I hope the banks and brokers take it on the chin.

It isn't deliberately incomprehensible. Banks own websites have calculators for you to figure it out.

It's important to the bank because banks make money on fixed rate mortgages buy borrowing money on the market and lower rates than you can access. So if they borrow on a 5 year rate to cover your 5 year mortgage they lose money if you don't meet your terms.

The end result of getting rid of IRD is higher fixed rate or higher fixed penalties. There is a reason that open mortgages are more expensive everywhere than closed mortgages. It's because they are more costly to operate.

Again if you don't understand IRD you should not sign a mortgage document without legal review.

This isn't a monopoly situation where you are forced to buy a closed fixed rate product from one bank. You have a choice of lenders and a choice of products.

It's Grade 9 Math FFS

[burn_this_city]

Hope it spreads here and I can get my $7k back.

[Cecil Terwilliger]

Originally Posted by GGG

It isn't deliberately incomprehensible. Banks own websites have calculators for you to figure it out.

It's important to the bank because banks make money on fixed rate mortgages buy borrowing money on the market and lower rates than you can access. So if they borrow on a 5 year rate to cover your 5 year mortgage they lose money if you don't meet your terms.

The end result of getting rid of IRD is higher fixed rate or higher fixed penalties. There is a reason that open mortgages are more expensive everywhere than closed mortgages. It's because they are more costly to operate.

Again if you don't understand IRD you should not sign a mortgage document without legal review.

This isn't a monopoly situation where you are forced to buy a closed fixed rate product from one bank. You have a choice of lenders and a choice of products.

It's Grade 9 Math FFS

Lol. You really think this is about people not understanding penalties?

It’s because all the calculators you speak of say your penalty will be a certain number but the banks use a posted rate, a number which has absolutely no bearing on the interest rate and isn’t even a real rate offered to clients, to falsely inflate the penalty by calling the real rate a “discount”. Except it’s not a discount. It’s the rate everyone gets. The posted rate is bull####. It exists to screw over consumers when calculating penalties.

The idea that you think this is about your grade 9 math skills is hilarious. You’ve completely missed the point and for some reason are insisting on being a dink about it insulting people.

[Bend it like Bourgeois]

Originally Posted by Cecil Terwilliger

It’s because all the calculators you speak of say your penalty will be a certain number but the banks use a posted rate, a number which has absolutely no bearing on the interest rate and isn’t even a real rate offered to clients, to falsely inflate the penalty by calling the real rate a “discount”. Except it’s not a discount. It’s the rate everyone gets. The posted rate is bull####. It exists to screw over consumers when calculating penalties.

That’s it.

I absolutely understand the thin margins on mortgages and why banks would protect themselves. I also know those margins are going to get thinner, so the pressure is on.

Trouble is, if the bank were going to make 5k off their customer, after the fun with numbers they charge 10k or 15k. And they arrive at that penalty using posted rates and discounts that most customers don’t know and can’t know til it comes time to pay it.

‘Sorry Ms Customer, you got an imaginary 1.5% discount before, and now we’re only offering imaginary 1% discounts, so I’m afraid you’ll have to pay an extra .5% penalty for risk we never took and profits we’d otherwise never had made. But hey. You shoulda seen it coming.’

[GGG]

The posted rate isn't some magical number. Its the posted rate at the bank. It is included in your mortgage documents. My renewal documents show posted rate - discount = your rate. Then in the payment penalty section show exactly how it is calculated using the posted rate. None of this is hidden.

It also makes sense to use a posted value rather than the actual rate as the costs for termination for the bank will be fixed as the variance in rate between different clients is the cost of the difference in risk between two clients. SO whether a person has a 2% discount or a 3% discount the cost of early termination to the bank is the same.

https://www.rbcroyalbank.com/cgi-bin...ator.cgi/start

Banks mortgage calculators ask you and explain what the posted rate is/was.

You know what the posted rate is when you sign the document. The customer CAN and SHOULD know before they sign up. The Posted rate of banks is BOC rate plus X. I will concede that if the difference between the posted rate and the BOC rate changes over the lifetime of your product you might have an avenue for complaint.

The difference between an open short term mortgage and a fixed mortgage is 1-2% or so. So the customer is getting 10k per year in interest savings as a result of their decision to have a fixed rate mortgage.

The outcomes of this law suit would be a move to fixed rate penalties which screws over consumers in general as interest rate based calcs will be considered "Too Complicated" to figure out. So the banks needing to protect themselves will just have higher rates in general or higher penalties to switch.

And to add the lawsuit is not that the difference between the posted rate and the interest rate leads to too high penalties due to IRD. Its that IRD leads to too high penalties compared to 3 months interest and is "hard" to calculate.

[GP_Matt]

GGG, what is the posted rate? Do some customers pay the posted rate or is it just a high rate to be used for interest penalties and qualifications?

Also, do you have any idea how much profit the bank makes on the penalty? I understand that it has to be there so the bank doesn't lose if interest rates drop allowing everyone to switch their mortgage and leave the bank holding the bag.

It feels really high such that anyone who has to sell their home during the life of the term is backed into a corner.

They signed the contract and I don't think the calculation is all that complicated so I don't understand the lawsuit but I still think the penalty is excessive.

[Bring_Back_Shantz]

Is the penalty excessive?

I guess the depends on if you consider something that is transparent, presented up front in clear language, and agreed to by both parties excessive.

[MillerTime GFG]

Originally Posted by GGG

It also makes sense to use a posted value rather than the actual rate as the costs for termination for the bank will be fixed as the variance in rate between different clients is the cost of the difference in risk between two clients. SO whether a person has a 2% discount or a 3% discount the cost of early termination to the bank is the same.

It’s really whether or not you fit their lending criteria. Yes or no based on debt servicing and credit/income requirements. There’s really no sliding scale for rate proportionate to risk. Your negotiating skills can impact your rate however.

Sure the commitment/renewal letters may include details on how their penalties are calculated, but I’d be willing to bet VERY few people understand the difference between being calculated on posted vs contract. To my knowledge, no lenders outside of banks (ie monoline lenders) base IRDs off posted rates.

[speede5]

What conditions would be in place to end up with such a large penalty?

I played with the RBC calculator with multiple scenarios and never got hit with more than 3 months interest.

[Cecil Terwilliger]

Originally Posted by speede5

What conditions would be in place to end up with such a large penalty?

I played with the RBC calculator with multiple scenarios and never got hit with more than 3 months interest.

Generally IRD protects against interest rates going down. Discourages people from paying the penalty just to get the better rate. Try it again but use 5.24 or 4.64 as the original rate (or enter in a discount of 2% if you're using the RBC calculator).

Here's a quick calculation from the ratehub based on paying out a $450k mortgage about midway into a 5 year term.

Spoiler!

Interest rate differential (IRD) penalty

4.64 % posted rate at original mortgage date - 3.44 % posted rate for remaining term / 12 convert to monthly interest rate = 0.0010 ird factor

0.0010 ird factor x $450,000 outstanding mortgage balance x 24 months remaining in term = $10,800 interest rate differential

3 months interest is only $3400. The problem of course is that the 4.64% isn't a real rate. The real rate is more like 2.99% and if calculated using that rate the penalty would be interest only. I don't know why banks aren't legislated (or would it be OSFI?) to ban using the discount or posted rate to calculate penalties. Seems like a pretty straightforward way to fix this.