Mortgages almost always have penalties associated with early payment or defaulted payments. The most common examples of penalties for early payout are expressed as the greater of three months interest payments or the interest rate differential (“IRD”). The IRD is a penalty that is often misunderstood, and rightly so, I would be willing to bet that both bankers and real estate lawyers would struggle to make the calculations.
The way IRDs occur seems to be a little questionable and perhaps financial regulators should monitor them more closely. Basically, the IRD is the difference between the “posted interest rate” at the time you acquired your mortgage and the discounted interest rate that you were granted when you obtained your mortgage. Banks, and other lenders, commonly discount their posted rates. For example, if the posted rate were 5%, when you applied for your mortgage, you may have been told you would get a special rate of 3.5% because you were a loyal customer. It is actually just a good sales pitch, because posted rates at banks are almost very close to being the same, if not the same, and offering you (and every other customer that may shop around) a discount ensures your loyalty to the institution.
Depending on the value of your mortgage, the difference between the interest rate granted and the “posted” rate, as well as the remainder term of the mortgage the penalty for early payout can be astronomical. This can occur when you are in a hot real estate market and if you are unprepared can cause a significant financial shock. Imagine you bought a house with the intention of living in it while fixing it up, to avoid capital gains taxes. Six months later, you still have a 2.5-year remainder term on the mortgage and decide it is time to sell and buy upwards. The new house is going to cost another $100,000 and the lender wants to be in first place, your existing mortgagee will not advance you the additional $100,000 and will not allow you to port the mortgage. You could be on the hook for tens of thousands of dollars of penalties.
When a property is abandonded and a legal proceding is commenced for recovery some property maintenance may be required, it is reasaonble for the mortgagee to anticipate recovery of these costs. However, if the mortgagee undertakes a renovation project in preparation for sale it is not reasonable for them to expect to get paid for such costs unless they are necessary for the preservation of the property.
Another form of penalty, that is actually not lawful, is the accrual of collection costs on unpaid mortgages. The courts have determined that a mortgage administrator may charge reasonable collection fees and that these fees may be precalculated in the mortgage document, however, they may not charge exorbitant amounts and any such amount must be in fact a fee for service and not simply a penalty. Some mortgage brokers send out stock letters on a regular basis to mortgagors in default, and charge hundreds of dollars for each. Interest rates may also be increased as a penalty for default, and again the courts have found this to be in contravention of the Interest Act.
Unfortunately for mortgagors in default they are not in a position to be able to afford legal counsel, who can challenge over charges and force a taxation of the proposed collection account. Most mortgagors in default are not sufficiently educated, sophisticated, or schooled in their rights and the law to properly represent them selves in court. Should apathy set in and the mortgagor not attend court the adjudicator may simply sign a default judgement with a full judicial review – since no one seems to care anyway – and the mortgagor may end up bankrupt while the mortgagee has made more money than they should have following the sale of the property.
If you or someone you know is in default under a mortgage call the office before things get completely out of control. For some folks, filing a bankruptcy or a proposal can improve cash flow and allow them to get caught up with mortgage arrears before they lose the house. 519-646-2222