Canada's New Mortgage Code Makes Prepayments Easier

 The Canadian government has introduced a new Mortgage Code of Conduct for federally regulated financial institutions. It requires lenders to clearly explain the differences between mortgage products, show how to pay off a mortgage faster without incurring penalties and explain how prepayment charges are calculated.
"In the low interest rate environment of the past few years, many people wanted to break their mortgage to take advantage of lower interest rates, but may not have understood how mortgage prepayment charges were calculated," says Terry Campbell, president of the Canadian Bankers Association.
Some financial institutions charge hefty fees for the privilege of paying off the mortgage early. The Canadian Bankers Association explains why: "When interest rates are declining and borrowers decide to break their mortgage contract, the bank will then lend that money to someone else at the current lower rate, resulting in a shortfall for the bank. The bank will allow the borrower to break the mortgage contract, but the borrower would need to pay a mortgage prepayment charge to help the bank manage its risk and cover its costs from the customer paying off the mortgage early. Typically those charges are three-months’ interest or the interest rate differential, whichever is greater."
But the Financial Consumer Agency of Canada (FCAC) says over the past few years it "has observed a significant increase in the number of complaints related to mortgage prepayment penalties.
Specifically, consumer complaints have primarily focused on the interest rate differential (IRD) option that appears in many mortgage agreements."
FCAC says the three main consumer complaints are:

Descriptions of the way prepayment penalties are calculated are vague and/or difficult to understand

Some of the components required to calculate the prepayment penalty are missing (such as the posted rate vs. the discounted rate) or there is no reference on how to obtain information required for the calculation

There appears to be a discrepancy between the prepayment penalty formula that is disclosed to consumers and the system calculation used by some institutions (for example, the estimated IRD vs. the actual IRD charge) The new code requires lenders to disclose the manner in which a mortgage prepayment charge is actually calculated. This will include the formula that is used to arrive at the actual charge to the consumer. A formula that produces an estimate does not meet the requirement, says FCAC.
Lenders must also provide a description of all the components included in the calculation. For example, if a present value calculation is used to calculate the penalty, the components must include variables such as future value, payment, effective annual rate, number of payments remaining and outstanding balance.
The code says that disclosure must be made in a "clear, simple and not misleading" manner, in plain language. FCAC says lenders should include an example/worksheet to help consumers figure out their own prepayment penalty.
The agency says many lenders "use mortgage prepayment calculations that are complex and may not be easily presented in a manner that is clear and simple, and therefore are not user-friendly for the average consumer." In such cases the disclosure documentation must also include a "simplified method (such as estimated IRD) through which the borrower can calculate a reasonable estimate of the prepayment penalty."
The code says lenders must also make available the following information:

Differences between fixed-rate mortgages and variable-rate mortgages; open and closed mortgages; and long'and short-term mortgages

Ways in which a borrower can pay off a mortgage faster without having to pay a prepayment (such as lump-sum payments, increasing the regular payment amount, and moving to a weekly or bi-weekly payment schedule)

Ways to avoid prepayment charges (such as porting a mortgage)

Actions by a borrower that may result in the borrower having to pay a prepayment charge, such as partially prepaying amounts higher than allowed by the mortgage, refinancing the mortgage or transferring the mortgage to another lender. Each lender will be required to post calculators on their public websites so borrowers can enter information about their mortgage into the calculator to get an estimate of the current prepayment charge. Many of the financial institutions already offer this feature.
Lenders will also be required to publish a toll-free telephone number that consumers can call to discuss their mortgage. Each lender must respond to the FCAC’s requirements by May 7, 2012 and they must fully comply with the new code requirements by Nov. 5, 2012.