Mortgage penalties shouldn't shock the pants off you!

We've all heard the stories about the person who wanted a lower interest rate or sold their house and had to pay $1,000's to get out of their mortgage.  When people ask me about a lower rate and I ask what will it take to get out of your mortgage they say "three months interest or some complicated thing I don't really understand".  It's that complicated thing you should understand. 

Today the government took some very important steps to ensure the banks help you understand the IRD (Interest Rate Differential) or "the complicated thing you don't understand".   In fact there are lots of enhancements to the code of conduct that will help the consumer make a more informed decision on their mortgage. 

Before I get too far into it let me explain the IRD in very simple terms.  It works like this.  An investor goes to the bank and invests money.  The bank guarantees the investor a rate of return on their money.  Then they take the invested funds and they give you a mortgage.  The investor makes his interest and the bank puts a little more on the rate to cover their cost of doing business.  After all they found the qualified borrower and will take the risk of you not paying.  So everything is going well and interest rates drop.  The investor is really happy because they are guaranteed the rate of return they invested in.  So when you go to the bank and say "hey, I'm paying way too much interest on my mortgage and I want a better deal" the bank would technically have to go back to the investor and say "you know that rate you're making on your investment? Well they guy we lent the money too wants out so we were wondering if you wouldn't mind taking less on your investment?" 

I think you can imagine there is no need for a bank to have such a conversation with an investor so instead they do this.  They look at the amount of interest they guaranteed the investor and then they look at what they will get by giving you the new rate.  The difference between the new rate and the amount they guaranteed is your penalty or "The Interest Rate Differential".  It's all very legal and has nothing to do with greed. 

So what changed today?   Now the bank will need to explain to you how that works before you sign your firm and legal binding contract.  They will also have to remind you on your yearly statement what a prepayment would look like for you.  Here is the exact wording in the new code of conduct that addresses this issue:
If the lender used the IRD to calculate the prepayment charge, the lender will inform the borrower of :

• the outstanding amount on the mortgage
• the annual interest rate on the mortgage
• the comparison rate that was used for the calculation
• the term remaining on the mortgage that was used for the calculation

I know government documents don't make great reading material but if you feel so inclined to understand this better I encourage you have a look at the actual document.  Before you ask your bank or anyone else to give you a lower rate on your mortgage it would benefit you to at least understand some of the language of banks.

As always if you have any questions you know I'm here.