The fact they exist isn't what is troubling. It is a problem when the penalty is arbitrary and unnecessarily complicated. The Globe and Mail discusses how lenders select an unrelated interest rate (the posted rate) when doing interest rate differential calculations, which end up favoring the lender.
The federal government was going to announce some regulation regarding mortgage penalties but has failed to do so. Reducing onerous mortgage penalties will reduce future foreclosures at the margin, which in addition to consumer protection should be the goal of regulation - not controlling asset prices.
Here comes the evil part.
At many big banks, they don’t use your existing 4.75-per-cent rate. What they do is take the posted rate at the time you took out your mortgage. This is a rate that has no relevance to you, as you never paid it. In fact, it likely isn’t listed anywhere on your mortgage contract. Remember the ridiculously high mortgage rate we talked about at the beginning of this article? Now you see what it can be used for.
....Because of this sleight of hand, you would now owe the bank an additional $12,000!
The Canadian Mortgage Trends blog recently wrote about some lesser know potential costs of borrowing. I don't have comment for each individual item, but when compiled into a list it seems the industry benefits themselves through technicalities and obfuscation.
- Restrictions on breaking your mortgage before the term is up
- Restrictions on breaking your mortgage for the first 3 years
- A penalty surcharge of 1% for mortgages broken within the first 12 or 36 months
- “Reinvestment fees” (on top of mortgage penalties)
- Interest rate differential (IRD) penalties based on an onerous bond yield calculation
- IRD penalties on variable-rate mortgages (usually IRD penalties apply to fixed mortgages)
- IRD penalties based on a costly posted vs. discounted rate formula
- Inability to port unless the purchase and sale take place on the exact same day (which can be hard to arrange)
- A poor conversion rate guarantee
- No refinances during the first year
- No free switches (for transfer-eligible mortgages)
- Amortization limits of 25 years
- Minimum amortizations of 15-18 years
- Restrictions on converting from a variable rate to a fixed rate for the first six months
- No ability to break your “open” HELOC without a penalty
- No pre-payments within 30 days of discharge
- Inability to port across provincial lines
- High administrative fees when porting
- 100% clawback of cash-back if the mortgage is broken before maturity
- Requirement for a full banking relationship with the lender
- No lump-sum pre-payment privileges
- No annual payment increase allowance
- Pre-payments restricted to one specific day a year (instead of any payment date)
- Borrow below your limit which reduces the chance of a forced sale during financial stress.
- Keep amortization periods as short as possible to avoid dealing with these fees for 25-40 years!
- Only buy if you seriously plan to stay in the house for awhile (5+ years)
- Avoid gimmick mortgages like the so-called "cash back"