Appearance before the Standing Committee on Finance (July 7, 2020): Prepayment penalties

Issue

Prepayment penalties exist on most fixed rate mortgages. Even following COVID-19 relief measures, consumers will likely be charged prepayment penalties if they sell their homes or refinance their mortgages before the end of their term.

Background

• After the 2008 global financial crisis, many consumers in the United States and other countries needed to sell their homes or refinance. In Canada, a notable impact of the crisis was that many consumers encountered prepayment penalties.  
• Coming out of that crisis, the Code of Conduct for Federally Regulated Financial Institutions: Mortgage prepayment information (the Code) was established to improve disclosure.
• Prepayment penalties are difficult to understand and can be for significant amounts of money.
• A significant proportion of mortgage complaints concern prepayment penalties.

Data/Quick facts

• Mortgage prepayment penalties are usually calculated as the greater of either
  • Three months’ interest, or
  • The Interest Rate Differential (IRD)
• Because the IRD is usually based on banks’ posted rates, it can be subject to large changes when banks adjust their rates.
• Many consumers do not understand how the penalties are calculated, and penalties are often larger than consumers expect.
• News stories about prepayment penalties have been reported in recent weeks. A recent CBC news story, for example, covered a consumer whose penalty was approximately $30,000. 

Key messages

• Prepayment penalties are set out in mortgage contracts and are disclosed to consumers.
• FCAC worked with banks following the last crisis to improve disclosure to consumers in accordance with the Code of Conduct for Federally Regulated Financial Institutions: Mortgage prepayment information Code. 
• The context resulting from the pandemic affords us an opportunity to re-think disclosure related to prepayment penalties to make it simpler for consumers.