How mortgage penalties can hurt you

Borrower beware. You will be charged a penalty if you get out of a closed mortgage before the end of the term -- and the penalty will be higher than you expect.

You may think the penalty is three months ' interest. That's the case when mortgage rates are stable or going up -- but not when rates are going down. Your penalty is either three months' interest or the interest rate differential (IRD), whichever is greater.

I spotlighted this issue in my Star column last year. Since then, I've received hundreds of complaints. And despite a few mortgage rate hikes, many people are still being asked to pay thousands of dollars to compensate the lender if they cancel prematurely.

There are only a few ways to soften the blow:

-- Take the mortgage with you if you sell before the end of your term. Of course, if you don't buy a new property and rent instead, mortgage portability won't help you.

-- Make a big prepayment before you get out of the mortgage. Borrow if you must to use all your prepayment privileges. This will lower the balance on which the penalty is charged.

-- Ask the lender about "blend and extend." This allows you to extend the length of your mortgage and blend your old interest rate with the new term's rate.

Check out a helpful publication from the Financial Consumer Agency of Canada on how to reduce penalty charges.

Finance Minister Jim Flaherty promised last February to introduce new rules on standardizing mortgage penalties. Lenders are all over the map on how they calculate them.

For example, many banks use the posted interest rate, which is higher than your discounted rate. This makes the IRD penalty greater than it should be.

Nothing has been done so far, as I said in a blog past last summer. If you want Ottawa to act on mortgage penalties, write to your Member of Parliament -- and send me a copy.

I want to see lenders give more disclosure of penalties (along with examples of how they work). They should be forced to advise you of your right to make prepayments.

If you're thinking of getting out early, find a mortgage broker who can negotiate a lower amount with the lender. It's hard to do on your own.