First off, it appears to be unfair. The concept of an extra payment even when you aren’t doing anything malicious seems a bit harsh. This is why you should explore more to find out all you need to know.
In general, a prepayment penalty or a breakage cost is a mortgage fee. A mortgage fee comprises of 3 months interest which your mortgage lender will charge upon the occurrence of certain circumstances. These circumstances are:
- When you make payments more than the accepted additional payments towards your mortgage;
- Breach your mortgage agreement with your mortgage lender
- Alienate or transfer your mortgage to someone else before the expiration of your term. The person you transfer it to then continues your mortgage payment from where you stopped. Although to do this, you need the approval of your mortgage lender.
- When you pay the mortgage fee earlier than the expiration of its term. Although, if your mortgage is an open mortgage, you will not pay a prepayment penalty when you pay your mortgage in full in a lump sum.
Canadian mortgage system requires Prepayment penalties or prepayment charges. So, contrary to what most people think, your mortgage lender isn’t trying to pull a fast one on you. In this article, you will get to learn more about the prepayment charge.
Prepayment Penalties Explained
Naturally, when everyone signs a mortgage contract, they do so, intending to complete their mortgage terms, pay off the mortgage fee, sell or transfer the said mortgage, or pay more than they should each month. Although it happens, people don’t plan to breach their mortgage obligations. These breaches are why stress tests exist.
A prepayment penalty or charge is the money your mortgage lender collects when you do something else than seeing your mortgage through to its prescribed term. This prepayment term consists of a minimum of 3 months, and it exists to protect your mortgage lender, or so people think. Although this charge exists, even the mortgage lender makes a profit, it perpetuates the mentality that it only benefits the lenders.
Furthermore, when you look at the prepayment penalty from the angle of a mortgage borrower paying off the principal amount in a shorter term than agreed, the mortgage borrower would have no interest to charge. Interest is how mortgage lenders make money from your mortgage. The longer the term, the more interest they get. Paying the mortgage off earlier would prevent this.
While we don’t dispute that the penalty gives mortgage lenders a particular advantage, people shouldn’t forget that these lenders take on risks with the mortgage. They bear the brunt of borrowers defaulting on their obligations. So, while this prepayment penalty or charge favours mortgage lenders, it is there to ensure that borrowers complete their obligations.
For instance, most times, mortgage borrowers in Canada don’t complete their loan term because they sell the house. Now, selling the house while escaping the mortgage obligations could negatively affect the mortgage lenders. So, the prepayment penalty or charge gives lenders financial assurance. As if this isn’t enough, mortgage lenders wouldn’t allow you to sell your mortgaged house to someone they disapprove of. So, lenders are protected at all fronts.
Even though mortgage lenders are trying to ensure to don’t run into a loss, this is overkill. They have high enough power when it comes to mortgages. They have the power to arbitrarily refuse the person you want to sell or transfer your mortgage to. Mortgage lenders are trying too hard to make too much profit. From the risk angle, they have other remedies to ensure borrowers’ commitment.
Apart from the fact that a prepayment penalty or charge gives the mortgage lender financial assurance in the form of extra profit, the prepayment penalty or charge itself is expensive. We can understand why no one wants to pay it. It makes the whole process more costly than it should be.
The Due on Sale Clause
As mentioned earlier, prepayment penalties or charges are part of the Canadian Mortgage system. As such, they feature in a standard mortgage contract.
Remember, the most common reason mortgage borrowers pay prepayment penalties or charges is because they want to sell their mortgage. Interestingly, you can sell said mortgage, but this doesn’t mean you are free from financial obligations. Cue the ‘Due on Sale’ clause, which triggers the prepayment penalties or charge.
Mortgage lenders can approve or refuse the person you want to sell your mortgage to. The due on sale clause gives them this power. So, you might not even be allowed to pay prepayment penalties. Your mortgage lender would prefer that you complete the mortgage payments before selling them off to another person.
This power that mortgage lenders have is somewhat arbitrary and subjective. They can decide to decline four transfers because the person you want to transfer the mortgage to isn’t creditworthy by their standards. Lenders have quite the power. Also, do borrowers. You can shop for who you want.
Is the Prepayment Penalty Enforceable?
This is the million-dollar question. Ordinarily, prepayment penalties are unenforceable because of Canadian contractual law. When a mortgage borrower breaches the mortgage, the seller is entitled to the borrower’s deposit. However, this is only when the deposit is a proper estimation of liquidated damages. So, on the surface, there is no room for prepayment penalties, but mortgage lenders found a way out.
The Canadian courts offered mortgage lenders a way out by declaring that a prepayment penalty or charge isn’t a contractual penalty per se. The court’s view is that the mortgage borrower is attempting to get out of an agreed contract early. So, the payment which the bank demands, which is the prepayment penalty, is not a penalty per se.
The court declared that such payment is like a payment that the bank demands as compensation for getting out of an agreed contract earlier than the stipulated time. There is a catch. Such prepayment penalty or charge must be reasonable. It must not be exploitative.
The prepayment penalty or charge can look unfair, but it is the financial reality of the Canadian mortgage system. You must conduct proper research before you choose a mortgage lender. Call us at 1-855-567-4898 for more Mortgage advice, Mortgage rates, and more. We are Best Mortgage Online.