APR stands for “Annual Percentage Rate.”
APR includes the contract interest rate which determines the monthly, weekly or bi-weekly principal and interest payment in addition to lender fees that are charged or can be incurred throughout the mortgage term.
The lender costs, although they don't affect the mortgage payment, are expressed as a percentage rate in the APR. Therefore, we can say the APR is the true cost of borrowing because it accounts for both the contract rate plus all other fees.
Despite disclosing standard APRs, it is impossible for a lender to calculate the true APR when it comes to Variable Rate Mortgages or the cost of penalties incurred through early termination. Because fluctuating rates and penalties definitely change the APR but can’t be predicted at the onset of a mortgage contract, determining absolute costs with certainty is impossible for both lenders and borrowers. As a result, neither costs are included in standard mortgage APRs but should be considered by borrowers with equal weight.
Fortunately, there are standard fees and calculation methods that can be considered by borrowers when mulling over mortgage options to ensure a lower cost of borrowing.
Lenders charge fees during mortgage terms which are mostly accounted for in the standard APR. For example, a lender may charge a property tax administration fee, NSF fee, discharge statement fee, fee for transferring the mortgage to a new property, fee for prepayment, fee for payment frequency change, etc.
These fees add up.
For example, if a lender collects $200 a year for each borrower's tax administration service, it will collect $200M for every one million borrowers. Therefore, small fees do add up in both costs and profits.
By paying their own property taxes and/or setting up a payment plan directly through their municipality, borrowers can reduce their mortgages' APR by cutting costs. Other costs, however, can not be changed or altered so it’s imperative that borrowers determine their total cost of borrowing - the total APR - before signing on the dotted line.
Variable Rate Mortgages
Although a mortgages’ standard APR is defined in the contract, variable-rates can change during the mortgage term increasing or decreasing the APR.
A variable mortgage rate fluctuates and depends on the Bank of Canada's overnight lending rate which is determined by factors affecting the global and domestic economy. Therefore, borrowers who choose a Variable-Rate-Mortgage must be aware that the APR can increase at any time.
Pre Payment Penalties
Mortgage contracts set out the written formula used by lenders to calculate prepayment penalties, but it’s simply impossible to calculate what a penalty could be at any point during the mortgage term at the time of approval.
Because the lender assumes the borrower will not exit the mortgage until the maturity date, penalties are not reflected in the APR. To calculate it properly, a lender would have to know, 1. When the borrower is exiting, 2. The remaining term of the mortgage, 3. The remaining balance left on the mortgage, and 4. The interest rate at the time of exit. These factors are all impossible to know ahead of time and it’s not certain whether or not a borrower will break their mortgage at all.
Realistically, it's not uncommon for borrowers to break their mortgage and, in theory, "the penalty" should be considered as part of the APR. But since it’s not, borrowers should choose a lender who doesn’t use the most expensive penalty calculation methods.
Major banks, for example, have the most costly penalties for fixed-rate mortgages. And, although all lenders have the same prepayment penalty calculation, which is “three months of interest or the interest rate differential (IRD), whichever is greater”, big banks take the most expensive route.
For example, banks use the Bank of Canada’s posted rates which are heavily inflated when compared to contract rates, and therefore, borrowers appear to have received a larger discount which, in turn, makes their penalty larger.
In comparison, monoline lenders use their current contract rates in the formula which are not inflated and which ultimately make their penalties cheaper.
In conclusion, when shopping for a mortgage, borrowers should choose lenders who have a lower cost of borrowing and more favourable terms in order to truly get the best deal.
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Sarah A. Colucci, Mortgage Agent Lic. M14000929
Mortgage Edge, FSCO Lic. 10680