Monday Morning Quarterback: Mortgage Break Fees & “Fairness”

A story came out last Friday about an Edmonton couple who was “devastated” to find out that they owed TD Bank $17,000 in mortgage break fees.

I was going to play devil’s advocate and point out the illogical nature of that couple’s thought process, but I figured I’d give them a break.

Now having mulled this over the weekend, I just can’t let this one slip by.  I’m sorry, but if you read the article, you’ll see that the home-owners were relying on some sort of divine intervention or “have-a-heart” mindset from the bank, and I find that to be naive, irresponsible, and part of a growing trend among society where people don’t want to account for their own decisions and actions…

MortgagePaper

Sometimes I think the world is a terrible place; a place where mankind, in large part due to the anonymity and voice that the Internet provides, are more negative, judgmental, and hurtful than they’ve ever been.  And you can always turn on your CBC news app at any time to read about the latest Toronto shooting or the next pedestrian struck by a car.

Then sometimes, I think the world is softer than it’s ever been, and it’s a change that’s taking away the tenacity and survival that’s helped mankind to survive for two-hundred thousand years.  Political correctness run amok, socialism in the public education system that breeds a generation of mediocrity, and by God, they’ve taken fighting out of hockey!

So when I read an article like the one from Friday’s CBC, entitled, “TD Bank Client Devastated By $17,000 Mortgage Penalty,” I can’t help but see the story in two different lights.

On the one hand, we all hate banks.  They’re not quite on par with Rogers and Bell, but we don’t like them.  I see a headline like the one above, and think about the poor-shmuck that got hit with a $17,000 mortgage break-fee, and I feel sympathy for him, and scorn for the faceless financial conglomerate.

On the other hand, I feel as though his story underscores a dangerous trend in today’s society toward people not taking accountability and responsibility for their actions.

As I read through the rest of the article, the latter feeling won out.

Read that article in full, and let me know what you think in the end.  If the comments on the CBC’s website are any indication, most people feel the same way.

But let’s backtrack for a moment and discuss mortgage break fees, what they are, why they’re present, and what you, as a responsible consumer, need to know.

Consider that when you ask the bank for a loan so that you can afford to purchase a home, with money that you do not have, you’re asking for something from the bank – something of value to you, and in return, the bank is getting something of value from you as well.

A mortgage is a contract, not unlike any other you would sign, whether it’s for employment, or goods and services, and there are terms and conditions within that contract.

As with any contract, there may, or may not, be the option of breaking, cancelling, or altering the terms and conditions, or the entire contract itself.

With a mortgage, we must remember that the bank is loaning you money according to a certain timeline, and with a certain expected return.

If the contract is for five-years, then the bank is putting their eggs in a 5-year basket; not an 18-month basket if and when you decide you want “out” of the deal.  The bank has made arrangements with and for that money, and they have proceeded accordingly.  There are costs associated with the bank changing course.

So when you, the borrower, decide that you want “out” of that mortgage – that contract that comes with terms and conditions, there is going to be a fee.  Call it a “penalty” if you want, but it’s the same thing.

That fee, or penalty, is spelled out in the contract that the lender and borrower both sign, and whether it’s on the front of page one, or buried on page-297, it’s in there.

Now, consider that mortgage rates float, and the bank is taking on an “investment” when they loan out money.

If interest rates at the time the mortgage was signed are at 5%, and 18 months later when the borrower wants out of the deal, prevailing rates are at 3%, then the bank has an incredible asset in this loan!  They have an above-market rate of return.

So if the borrower wants out of the deal – a 5-year “contract,” after only 18-months, the bank may elect to let the borrower out of the deal, but then they would turn around and only be able to loan that money at 3%, and not 5% as was the case with that 5-year mortgage.

That, ladies and gentlemen, is why we have “interest rate differentials,” and they are not, in any way, shape, or form, unfair.

“Fair” is a relative term in today’s society.

Every time the word “fair” is uttered, you almost want to follow up with the term “first world problems” just to put that “fairness” in perspective.

So if a borrower takes on a 5-year mortgage, and if that borrower wants to terminate the mortgage early, and if interest rates have changed since the mortgage was signed, then how is it “unfair” for the bank to take the IRD?

Let’s now return to the CBC article, and keep in mind before we do, that I’m not seeking to assault this lovely Edmonton couple, but they are the ones that called “Go Public” and sought the help of the media.  They put themselves out there, and just as I put my opinions on this blog, along with my name, and risk taking heat from “Mike,” or “Noel,” or “Condodweller,” or anybody else on a regular basis, I don’t think it’s unfair for me to examine and potentially scrutinize these folks, their actions, and their complaints.

The Edmonton home-owners were “expecting” to pay only $4,000, based on three months’ interest.

That’s their first mistake.

Most mortgages today contain the phrase “…..the higher of three months’ interest or the interest rate differential.”

I know that these folks are not mortgage experts, but they did sign a contract.  They can’t simply assume that the bank will give them the lower of the two because they want it to be so.

The CBC article explains, “The IRD is based on a complicated mathematical formula that includes the principal owing, the months remaining on the mortgage’s term, and a comparison of the interest rate the client is paying versus the rate the bank would charge for the remainder of the term.”

I couldn’t possibly disagree more.

If the IRD is a “complicated mathematical formula,” then what the hell are those first-year university students doing at Waterloo?

Now here is where things get really interesting:

For the past two years Trusz has been a board member of the Haitian Children’s Aid Society (HCAS). He’s made three trips to Haiti to help reconstruct an orphanage for 60 children in Mirebalais, in the centre of the earthquake-damaged country.

This summer, the Truszes decided to sell their home and his business and move to Haiti to help run the orphanage for up to 10 years. Trusz said the family had budgeted to live in Haiti on $24,000 a year.

“We have some money set aside for project costs, to buy land, create businesses. We’re going to be using our own money to do that – and so when all of a sudden we’re going to have $17,000 less than we thought we were going to have, we see that in human terms.”

Alright.

So, it would seem to me that, and correct me if I’m wrong, these people believe that the reason they want to break their mortgage matters as far as the bank is concerned.

Is there any other way to read this?

Now I’d be remiss if I didn’t congratulate these folks for the incredible work that they do, their selflessness, and the fact that they’re doing something that literally one-in-a-million people on our planet would do.

But having said that, the idea that the mortgage break-fee doesn’t apply to them because they’re doing this humanitarian work sets a really bad precedent for society.

What if everything we did in life worked like this?

The next time I get parking ticket, should I tell the parking enforcement officer, “If you write me that ticket, I’m not donating $1,000 in clothing to Elisa House again this Christmas?”

Okay, maybe that’s different, and maybe it’s not the quite zero-sum-game that the Edmonton couple is experiencing.

But the situation still reeks of somebody who shot first, asked questions later, and then tried fruitlessly to put that spent bullet back in the gun.

A few years ago, I sold a house to clients who turned around twelve months later, told me they were getting divorced, and said they wanted to sell.

I told them that they were going to lose money – having paid land transfer tax, having to pay real estate fees, lawyers, and break their mortgage.

I told them they should find a way to keep the house, or have on person buy the other out, or for the love of God – go to a marriage counselor and work it out!

I broke down the numbers, and laid out how the fees would work, and they were aghast at the $22,000 mortgage break fee.

But the woman simply brushed it off, and said to me, “Don’t worry, I’ll call the bank tomorrow.”

I asked, “What do you mean?”  I had a feeling I knew what she was getting at, but I was hoping I was wrong.

She said, “I’ll tell them that we just can’t pay that fee, that it’s ridiculous, and I’m sure we can work something out.”

Is this what we’ve come to as a society?

The level of naivety was off the charts!

“Hello, bank?  This is Jane calling.  You know that twenty-two large we owe you?  Well we don’t really want to pay that, so we’re hoping you can just not charge it to us.”

This wasn’t quite like waiving an overdraft fee!

These people bought a house, and took out a 5-year mortgage.  Did they not understand the seriousness of that commitment?

In the case of the Edmonton couple from the CBC story, it seems that they did understand the commitment, but they would just rather not have the unwanted result apply to them, on account of them somehow occupying the moral highground.

But what about the next person in line who doesn’t want to pay the break fee?

What if the next person is selling his house to pay for private school for his kid?  Is that a rung down on the ladder from opening a Haiti orphanage?

What if the person after that is selling his house because he, sadly, was laid off…….for poor work performance.  Then how does the bank evaluate his request to have the mortgage break fee waived?

Folks, tell me that I’m being insensitive here, but it comes with purpose.

You can’t just say, “I really want to have a child” and then after seeing how your life changes in two years, say, “I don’t want this anymore.”

How is the content of the CBC story any different?

A mortgage is serious business, and if a borrower doesn’t understand the terms or the risks, then that person should hire somebody who does.

I always recommend a mortgage broker to my clients, since I know they’ll actually explain things like mortgage break fees.

A few years back, when the “stripped-down” mortgages at 2.99% (remember when that was “low”?) were becoming all the rage, my mortgage broker was screaming about how there were no features – no portability, no pre-payment, and massive break fees!

But consumers gobbled up the low-rate mortgages without doing any homework, and you just know that somebody finding out they have to break the mortgage and get a new mortgage when they sell their condo and buy their house, is screaming foul.

And the Edmonton couple in the CBC story simply used their bank “who they had banked with for 20 years,” which is a serious no-no in today’s mortgage environment.

With naivety being the theme of this story, this couple was wrong to assume that a 20-year relationship with their bank would help them, when in today’s market, it hinders them.  Banks prey on people who they know are loyal, and who they know won’t look for a mortgage anywhere else.  These banks simply expect the business, and spend their time working hard for consumers at other financial institutions.

It’s a tough world out there, folks.

And I feel for the people in the CBC story, while commending them for their charity work at the same time.

But you simply can’t make decisions, and take actions, with the expectation that an unsatisfactory consequence can be altered to your liking…

24 Comments

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  1. Maggie says:

    I don’t feel badly for those people at all and I think it is pretty pathetic of them to have brought their issue to the media. We all deal with the consequences of our choices. Kudos to them for their charitable work.

  2. Cool Koshur says:

    I had been in same boat as this couple. My first mortgage was 5 year fixed at 3.5%. I was aware of the IRD clause. Fourth year in my mortgage I decided to upgrade to bigger home. If I broke my mortgage I had to pay something like 18K. I had 200+K mortgage still left. I talked to my bank and told them about my situation. Since I was taking more mortgage ~450K . They offered me a deal called “blend mortgage” for last 15 months rather than loosing my business. where I ended up paying 2.39% for last 15 months. Bank got compensated by earning the bigger interest since mortgage is front loaded. I think it was win-win for both. I am not sure about the situation of this couple. Are they cashing out, downsizing or upgrading? As long as they continue to give business to bank I am sure they will cut a deal

    My biggest concern with IRD is posted rate vs discounted rate. Posted rate is at least 3% higher than discounted rate. Banks use posted rate to calculate IRD which I think is UNFAIR. Rest I agree with David & others that buyer is responsible for mortgage when they signed the papers.

    I also agree with above comments that vast majority of homeowners has no clue about how mortgages work? what is IRD? What is front loaded? Amortization? All they see is whether they can service monthly mortgage payments

  3. Free Country says:

    Thank you for another excellent article David. I could make so many comments but I will try to restrain myself:
    — It never ceases to amaze me how some people expect others to pay for their financial illiteracy.
    — Like you, I have seen several of these CBC Go Public articles and pieces on The National. They are all the same – big bad bank/insurer/company did something bad to me. But when you step back and examine the claims, there are often good reasons for what the bank or insurer or company has done. (Not always, but often – CBC Go Public’s record is about 50-50 on this, which in my view is way below par for proper journalism.) Banks in particular, however, do not can cannot give a full-throated defence of their actions due to their duty of confidentiality to their customers, however, so the reader/viewer hears only one side of the story.

  4. H Marshall says:

    I have a question about mortgages.

    If your condo association announces a special assessment or that it is going to take out a by-law loan, do all the owners have a duty to inform their mortgagees? If they don’t, when they find out, can the banks cancel their mortgages?

  5. Kyle says:

    I am not a mortgage expert, but somethings i would consider before breaking a mortgage:
    1. Always find out from your mortgage person how much it will cost BEFORE you break it. Then decide if you still want to break it, don’t assume anything.
    2. Most mortgages offer early renewal options (up to 6 months before your renewal date), if you early renew into a VRM just before you break your mortgage, there’s usually no IRD on VRMs.
    3. If you can port some or all of your mortgage, there typically isn’t any IRD penalty. At least that’s my experience…YMMV
    4. If you’re switching mortgage providers, get the new mortgage provider to do the math to make sure that the new offer will make up for the penalty before moving.
    5. Sometimes there isn’t anyway to avoid a penalty, but you can reduce it by borrowing the maximum allowable prepayment amount from a LOC to reduce the principal that the penalty is calculated against.

    Interesting that in 2012 TD responded to a survey saying they use the Contract Rate (i.e. whatever rate is on your mortgage) to calculate their IRD, however the CBC story from 2014 indicates that TD is using Posted Rates (i.e. whatever number they feel like) to calculate the IRD.

    More useful information below:
    http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2012/08/3-month-penalties-arent-always-clearcut.html

    1. jeff316 says:

      Well put. I’d suggest repeating step number one every day that you’re truly seriously considering breaking your mortgage.

      We were close to breaking our mortgage – had done all the IRD calcs and confirmed them with the bank – and as we sent in the papers for review, well whatdoyaknow! the branch’s posted rates went down, increasing our penalty by a paltry $10 000. Classy.

  6. Ralph Cramdown says:

    There is no bank out there that funds its book as if no mortgages are going to prepay, and then has to “change course” when Jones balefully tells his bank manager that he’ll be breaking his mortgage. The employee who models prepayments can predict what % of the book is going to prepay this quarter, and management funds accordingly. Prepayments are probably re-lent within a week or two, and probably on another full five year term.

    There are costs associated with redeploying the money, like another home inspection, broker’s fee and contribution to overhead, but these costs seem to be much lower at the monolines, if they’re related to the break fee at all.

    The most charitable explanation for banks’ high break fees is that they have higher overhead than non-bank lenders, but must be competitive on interest rates, so people who break their mortgages must absorb the banks’ higher overheads for all mortgage customers.

    But I don’t believe that. I think that the banks compete on interest rates as much as they have to, but use sky-high break fees as a valuable option or booster for their interest margins, knowing that maybe 1/4 or so of mortgages will prepay. And I say this as a happy bank shareholder.

    In many cases, I don’t think it’s true that a customer ought to have known what the prepayment was. You don’t get presented with those terms and formulas when you’re shopping, but at closing as part of a large package of papers to sign here, here, initial here and sign here, or be unable to close. And a few years ago, CIBC’s clause was “The prepayment charge will be the higher amount of the following two amounts each of which will be calculated by us using a method determined by us from time to time at our discretion.” How’s that for vague?

    1. jeff316 says:

      Bang on. Mortgage contracts and their terms and conditions, beyond the rate and some payment privileges, are rarely presented before closing. That makes them almost contracts of adhesion. You have no ability to negotiate more favourable penalty terms when the stakes potentially involve not selling your house or losing the deposit you made on your purchase.

      During my last mortgage shopping experience I was never presented with the penalties when going through the approvals process.

      Of the five providers I was considering, three lenders refused to confirm the penalty formula beyond “the great of three month’s interest or IRD”. For the fourth lender, another a broker sent me the penalty from a previous client’s mortgage with the caveat that the penalty could be different from what I would see in my contract. And for the fifth, well they were upfront about the penalty formula but included a variable in the calculation that they can change at any time without notice.

  7. condodweller says:

    “Folks, tell me that I’m being insensitive here, but it comes with purpose.”

    You are being insensitive. In several places in this article in fact but I’m going to leave it at that and just say you can’t qualify or rationalize insensitivity.

    Now regarding the topic at hand. Technically you are correct of course as everyone should be aware they are signing a contract, they should be aware the terms and conditions are part of the contract, they should also be aware whether or not they read the contract all terms apply to them even though it does not provide sufficient information to make an informed decision, and understand that the bank will use every clause to extract as much money from you as possible because you are “breaking” the contract on a five year commitment.

    People often don’t even get a lawyer to review their purchase agreement, how likely is it that they will get their lawyer to review their mortgage contract? Since you do need a lawyer to complete the purchase, actually that’s wrong, you could actually do the work yourself, why not get the lawyer to review your mortgage contract and explain it’s implications?

    IMHO anytime the terms and conditions exceed a couple of paragraphs, the purchaser should have to sign a release that includes a Miranda type warning that anything can and will be used against them and that they have read and understood or were given the opportunity to seek independent advice to explain all clauses in the contract. Even a cooling period might make sense.

    While we are at it I also think banks shouldn’t be allowed to up-sell, no make that force-sell other products when you get your mortgage. When I bought my first place I was given a line of credit and a high limit visa card I didn’t ask for each with it’s own life insurance that I was never asked if I wanted. I’m sure I signed for it somewhere, or maybe not. I canceled the insurance but kept the credit line and visa card. If they didn’t give me a credit line then, I would probably still would not have one today. I kept it because I rationalized that I was not going to use it and it can’t hurt in case I needed it down the road. I have paid thousands in interest since as I used it to fund downpayments on other investments but how many millions have banks made off of people where they just racked up consumer debt on their line of credit that they didn’t ask for?

    I’m going off on a tangent here, my point is that many buyers who think the banks play fair just expect a simple process of taking the loan and makinng monthly payments to pay it off over the years. It may be naive but I think it should be reasonable to expect that our big 5 banks will treat us fairly. If you go to Cash Money to get your mortgage then yes I agree you should have shileds up and question everything. I think it’s sad that we need to be fully paranoid with a “reputable” bank everytime we sign a mortgage contract.

    I know that David holds this person fully responsible, I however would give them the benefit of the doubt that they did not read every single page of their terms and conditions or if they had, they didn’t fully understand its potential financial implications. Until the banks come clean and provide fully transparent terms I would advise every single person in their situation to complain and challenge them on it.

    The other problem is that banks continually change the landscape to stay ahead of consumers who are trying to stay on top of the rules. I don’t know when IRD was introduced but it wouldn’t surprise me if it came into play after the 3 months interest rule was put in place.

    How many people know that they are supposed to call the bank and let them know if they lose their job? Or that the bank can change your interest only credit line to interest + principal payment drastically increasing your payments whenever they want? Heck, do they know that their mortgage is callable and your friendly bank can force them to sell their home? There are millions of people out there who have no idea about some of the terms and conditions they signed.

    1. Joel says:

      As a simplified version everyone knows that if they break their phone contract within 2 years they are going to have to pay a fee, even 15 year olds understand this. Why is it unreasonable for a person making a $400,000 purchase to understand the same concept?

      1. jeff316 says:

        One could argue that if we need to regulate how/when/what cell phone providers can or must do re: breaking $2000 cell phone contracts, then we certainly should be doing the same for $400 000 mortgages.

        1. Joel says:

          Yes, I think that we should.

    2. RPG says:

      Condodweller your comments consistently echo the softie that David mentioned in the intro.

      FWIW I agree with those sentiments, especially those about the public school system. But that is probably way, way off topic.

  8. Joel says:

    As a mortgage broker I see this all of the time. People make a decision to sell without properly looking into what it will cost them. Banks generally charge more than monoline lenders in terms of break fees, but they need to be compensated for the work they have put in and the money lost.

    It is sad that these fees are not explained better upfront. This couple acted hastily and then went to the media when they didn’t like the results. It is great to have media help out people that are actually being wronged, but in this case the home owners understood that they have to pay a fee. Had they looked into this prior to selling they could have rented their house out for a year or two, then sold with no fee and had thousands of extra dollars to use in their passion project.

  9. Marina says:

    Disagree 95% with above two commenters.

    IRD is NOT complicated. It really isn’t. The reason so many people complain is that so many people lack basic financial literacy. This kind of math should be taught in high school so people are at least somewhat equipped to function in today’s credit-fueled society.

    The 5% I agree with is posting tables of possible break fees so people get a sense of what they will be paying.

    I used to work in financial services, specifically in mortgages on the bank side, and I have listened to more Collections calls than I care to recall. But a common theme is that people simply don’t understand how mortgages work. And almost NOBODY understands how amortization works. If one more well-educated person tries to explain how banks front-load your interest payments, I’ll scream!

    Oh, and if you REALLY are in distress (job loss, illness, etc), most banks will work with you. They won’t just let you walk away, but they will work with you. And if they don’t, ask for a manager. Go to your local regulatory body. Call a non-profit credit consolidation agency. ( Do NOT under any circumstances work with a for-profit agency, EVER. )

    Going to Haiti is not distress. It’s noble, but the bank doesn’t owe you anything.

    1. condodweller says:

      @ Marina How many PBOs who sell mortgages do you think out of a hundred would be able to to do the IRD calculation if you gave them a pen, a piece of paper and a basic calculator?

      1. Marina says:

        That’s why I think the tables showing sample fees are a good idea. it doesn’t make the IRD calculation any more complicated.
        I’ve seen people struggle to calculate a 15% tip – doesn’t mean that’s complicated either.

      2. Kyle says:

        Regardless of how many people are capable of calculating it, 100 out of 100 mortgage holders/seekers are capable of asking , “How much to break my mortgage?”

        The complexity of the formula is moot, it could have been as simple as A+B, the point is these people were working under their own set of incorrect assumptions, instead of simply calling and asking.

        “Shane and Joy Trusz say they were expecting to pay a penalty of three months interest, which would have been less than $4,000.”

        “Trusz said he expected TD Canada Trust, with whom they have banked for almost 20 years, to make an exception in their case, because they are selling their possessions to do humanitarian work.”

        1. condodweller says:

          The worst part is banks often will not tell you how much it is to break your mortgage. As an informed consumer I want to know how to do the calculation to be able to confirm it. I know of someone who wanted to break their mortgage to go after a better rate and he couldn’t get a straight answer from his bank. They were more interested in keeping his business and tried to undermine the other institution by creating fear and doubt in him by asking questions he didn’t know, or needed to know.

          1. Kyle says:

            When the bank charges you $17K in break fees and you are seeking recourse. Having your own calculation of $7K is of little value. Whereas if your Banker has told you that it would be $7K (especially if its in writing) is of immense value.

    2. jeff316 says:

      You’re missing the point entirely. IRD is not complicated in principle. The math isn’t the problem.

      The problem is in how staff represent the math, the variables inserted in the math, the license that financial institutions have to change those variables, and how the formulae vary across institutions. That’s the problem.

      I have no doubt that the staff involved in this case probably downplayed the likelihood of being charged an IRD, but tough nuts – this family should have been made to pay their penalty. But no one can suggest that banks have been straightforward with IRD calculations and penalties.

  10. Appraiser says:

    While I agree that borrowers must take full responsibility for the contracts that they sign, mortgage-break fees are the number one complaint fielded by the banking Ombudsman’s (OBSI’s) office.

    http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2016/04/three-big-mortgage-complaints.html

    It should also be noted that some lenders impose the posted mortgage rate, not the contract rate which is often much lower, to calculate the interest rate differential.

  11. jeff316 says:

    That couple? It is accidental but they are right – for the wrong reasons.

    The howls of rage should not be about the penalties themselves, but about the self-serving way financial institutions set up complex formulas that, in many instances, they can fiddle with through baloney like posted rates, investment return rates and inflated initial discounts to increase the amount.

    And how they can often do this at the last minute, throwing all the work you’ve done to get a new mortgage into disarray.

    The role for government here is to standardize penalties across the industry – either three months interest, or a percentage of the remaining balance, or a regulated, standardized IRD.

    They should also require better disclosure of potential penalties. If the government can require cell phone and car sales to disclose APR, then they can surely require consumers to sign off on a better disclosed penalty formula – separate from their mortgage forms – which includes a short table of potential penalties calculated according to projected remaining balances each year.

    1. Negotiator says:

      Jeff, the disclosure that you’re proposing is already given to mortgagors, and the form of disclosure is heavily regulated.

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