What Is A Pre-Payment Penalty & Why Do Lenders Charge Pre-Payment Penalties?

A pre-payment penalty is a clause that is set out in a mortgage contract. In the event the borrower exits their mortgage contract and term early, there will be a penalty for pre-paying the mortgage. Such events that trigger a prepayment penalty include refinancing, selling your property, and paying down a mortgage beyond its allotted pre-payment privilege. 

They will base the penalty that is calculated upon the remaining mortgage balance and a few months' worth of interest or the interest rate differential, in most cases, whichever is higher. 

Why do lenders charge a pre-payment penalty?

Lenders charge a pre-payment penalty to protect themselves against any potential risk prepaying the mortgage early may cause. Essentially, this charge protects the lender against financial loss.

​A mortgage lender or mortgage broker should break down the costs associated with leaving the mortgage early when the mortgage approval is given. Different lenders use different calculations so it's important borrowers understand how their prepayment penalty would be calculated in the event they exited the mortgage early before they agree to borrow the money. 

Annual Percentage Rate (also known as an APR) 

The APR indicates the total cost of borrowing.  The APR is expressed as a percentage and it incorporates all fees associated with a mortgage that are not compounded. For example, an administration fee to pay your property taxes with the mortgage would be reflected in the APR. There are different fees associated with each lender. A lender may or may not charge administration fees; but if they do, it would be reflected in the APR. 

The APR is usually reflected in an interest rate (%). A Mortgage Broker or Bank Specialist can break this down for you by showing you total fees associated with your mortgage noted in the Mortgage Commitment. 

Land Transfer Tax

Land Transfer Tax is a charge paid to the provincial Government when you purchase real estate in Canada. It was commenced on July 19, 1989 pursuant to the Land Transfer Tax Act. In Toronto, there are two types of land transfer taxes: (1) Provincial Tax, which is the nationwide standard tax and (2) Municipal Tax to the City of Toronto. You must pay land transfer tax if you buy an interest in property in Ontario. 

Land Transfer Tax is calculated on the amount of the land or the subject property. It is also payable in addition to the mortgage amount owing on a property or the debt assumed on a transfer conveyance. 

How Land Transfer Tax Is Calculated.

If an agreement of purchase and sale is entered into after November 14, 2016, and registration or the disposition occurs on or after January 1, 2017, the tax rates on the value of the consideration are as follows:
​
  • amounts up to and including $55,000: 0.5%
  • amounts exceeding $55,000, up to and including $250,000: 1.0%
  • amounts exceeding $250,000, up to and including $400,000: 1.5%
  • amounts exceeding $400,000: 2.0%
  • amounts exceeding $2,000,000, where the land contains one or two single family residences: 2.5%.

Maturity Date

The Maturity Date means the end date of a mortgage contract. It's the date of mortgage expiry and when the mortgage must be repaid out in full or has come due. The mortgage balance must be repaid on this date. 

Interest Adjustment Date

The Interest Adjustment Date is the date that a lender starts collecting interest on the loan. Interest adjustment dates usually fall on the first of the month. If a mortgage is registered on another day, there will usually be an interest adjustment payment taken before the first official payment.

Pre-Payment Privilege

A pre-payment privilege is a clause built into a mortgage contract that allows a borrow to prepay a certain percentage of their original mortgage loan each calendar year.  

What is a Collateral Mortgage?

Unlike a conventional mortgage where the terms are all predefined before the mortgage is registered, a collateral mortgage is based on the assumption that the borrower may take out additional credit products with the same lender down the road. A Collateral Mortgage is not a mortgage at all, it is a Promissory Note, and the terms can often be very different to the terms of a conventional mortgage. A Collateral Mortgage is registered for up to 125% of the property's value at an interest rate of around Prime, plus 10%. This is to take into account any possible credit taken out in the future by the borrower and its varying interest rates. 

The entire premise of a Collateral Mortgage is to register one mortgage at a higher amount and a higher interest rate so the borrower does not have renegotiate the mortgage should they require additional credit in the future. The downside to a Collateral Mortgage is it marries a borrower to the particular financial institution disallowing them the opportunity to obtain future, secured credit products with a different financial institution. 

What is a Conventional Mortgage? 

A Conventional Mortgage means it's a mortgage where all of the terms are agreed upon beforehand. For example, interest rate, term, mortgage amount and amortization are all agreed upon beforehand.