Disclosure vs. maximizing profit: Homeowner hit with extra $10K penalty for ending mortgage early
Canada's convoluted rules for prepayment penalties cause issues for consumers, lawyer says
A Toronto man is warning people to take a close look at the penalties they'll face for breaking a mortgage before they lock in, after his paperwork didn't include important information that would have saved him more than $10,000 in fees.
"I was frustrated that a key piece of information hadn't been disclosed to me," Nadim Kara says.
"Particularly as that piece of information wasn't in the mortgage contract so I had done what I thought was my due diligence and you know, I read the papers. I read the contract, I called them, I check in online."
Mortgage contracts have to disclose all information on penalties for ending a mortgage early and how they will be calculated.
Kara didn't know it then, but missing from his mortgage contract was information about a little known rule — homeowners with a fixed term longer than five years can only be charged a penalty of three months' interest if they break their mortgage after the fifth year, not the much higher interest rate differential fee.
In Kara's case, if he had waited just 60 more days, his penalty would have shrunk from $13,000 to $3,000.
While Kara's issue has now been resolved, he's frustrated no one is taking responsibility and worries other Canadians may be paying higher penalties than they should be.
In 2012, Kara and his wife moved from Ottawa to Toronto, renting out their Ottawa house, hoping it would increase in value over the years.
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By February, that hadn't happened and they were losing money, so Kara started looking into the cost of selling — reviewing his mortgage documents and contacting his mortgage company, First National Financial, to ask about penalties for breaking his mortgage early.
By the time the Ottawa house sold, Kara was less than two months away from the five-year mark on his mortgage — and that big reduction in penalty costs.
The fees associated with paying out mortgages early top the list of Canadians' complaints to the country's banking ombudsman, according to numbers provided by the independent investigator.
Experts say the rules, which apply to some lenders but not others, are so convoluted they leave Canadians who break or renegotiate mortgages confused and suffering from "sticker shock" when they are dinged with massive fees.
"If I had all the information in front of me, I would have made a different decision and I think that's the key," Kara says.
'Duty of care' not met, says homeowner
He found out he could have saved thousands only after the sale closed; the information was in the mortgage discharge papers provided by First National.
"I think there's a duty of care to your client, to walk them through the options and to be transparent. And I don't feel that's what happened here," he says.
The next day, May 2, he asked the company to refund the $13,000 penalty and charge the three-month interest fee of $3,000 instead. It initially refused and repeatedly told Kara it was "case closed."
"I mean we're not buying a sweater, right? This is a multi-hundred-thousand-dollar purchase," Kara says. "There is an inherent conflict in financial institutions, between disclosure and maximizing profit."
More than a month later, and just hours after First National learned Go Public was involved, the company changed its mind and agreed to charge Kara the $3,000 penalty.
Go Public put the issue to both First National Financial and the brokerage, Integrated Mortgage Planners.
"After taking all circumstances into consideration, and in the interests of maintaining goodwill with this borrower, we made the decision to decrease the prepayment fee and a refund was made to Mr. Kara," Robert Inglis, chief financial officer of First National Financial, tells Go Public in an email.
"We concluded that our calculations had been made in accordance with his mortgage terms. Notwithstanding, we noted that written disclosure of his prepayment privileges and fees could have been made clearer by his mortgage broker at the time he entered into his mortgage," Inglis wrote.
The broker, Dave Larock, tells us he did verbally inform Kara and his wife of the five-year repayment rule when they signed the original mortgage documents in 2012, but couldn't include the information in the mortgage documents because they are "system generated" and "cannot be modified." He also says the documents meet "every standard required by the regulator."
Larock took the extra step of following up with Kara near the five-year anniversary of the mortgage to talk about options, but was unaware Kara had already sold the house.
Convoluted rules cause problems
What happened to Kara is an example of how Canada's convoluted rules around the disclosure of prepayment penalties are causing problems, according to civil litigation lawyer Kieran Bridge.
Most federal rules, he says, apply to banks but not private lenders like First National, which fall through the cracks.
Bridge also says bank mortgages aren't without problems. He's argued successfully in cases where banks incorrectly applied complicated mathematical formulas to calculate penalties or failed to clearly disclose penalty information to homeowners.
Under federal legislation, banks should disclose how mortgage break penalties are calculated and how they will change over time.
Homeowners also have certain responsibilities, he says. Many don't pay attention to what ending their mortgages early will cost them at the time they lock in. The other issue, he says, is with the technical language used in the documents they sign.
For example, in Kara's case he was told his penalty would be calculated according to a method called the interest rate differential (IRD). Typically, penalties on fixed mortgages are calculated using whichever is higher, three months' interest or IRD. With today's interest rates, the IRD is always a much higher fee.
"That is one of the things I looked for — what was in the paperwork that the customers were given when they entered into their mortgage? What did it say about what prepayment penalty they might have to pay and how it will be calculated?" Bridge says.
'Clear direction' needed, lawyer says
In 2010, the federal government's budget included a promise to standardize the calculation and disclosure of mortgage prepayment penalties. Despite those promises, not much has changed, Bridge says.
"I think that the government does have a role here in providing very clear direction through regulation on what disclosure is required prior to these types of transactions taking place," Kara says.
He has some advice for consumers looking to break their mortgages.
"I think the number 1 thing I want them to know is that the first question to ask is ... What are all of my options today and in the near future with respect to breaking my mortgage and how does the penalty that I will have to pay change today versus whether I wait months or years?" he says.
"I don't want this to happen to anyone and I really, above all, I just want other people to have this information so that they can protect themselves."
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