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  5. > CG-8 Mortgage Prepayment Penalty Disclosure

CG-8 Mortgage Prepayment Penalty Disclosure

Publication date: March 5, 2012
(Amended Date: April 13, 2012)

Background

Over the past few years, the Financial Consumer Agency of Canada's (FCAC's) Compliance and Enforcement Branch (CEB) has observed a significant increase in the number of complaints it has received related to mortgage prepayment penalties. Specifically, consumer complaints have primarily focused on the interest rate differential (IRD)1 option that appears in many mortgage agreements.

Mortgage prepayment penalty disclosure has always been an important issue for FCAC. In 2002, CEB undertook a high-level industry review to assess the extent to which mortgage prepayment penalty calculation components were present in disclosure documents sampled from seven federally regulated financial institutions (FRFIs).

Following the review, all FRFIs were instructed to review the prepayment clauses in their disclosure documents to ensure compliance with the regulations.

The increase in the number of complaints received by FCAC regarding mortgage prepayment penalties seems to indicate a broader spectrum of issues with all types of financial institutions.

Requirement

Legislation sets out that a FRFI that enters into a credit agreement for a loan shall disclose to all borrowers:

  • whether they have the right to repay the amount borrowed before the maturity of the loan
  • any terms and conditions relating to this right
  • the manner in which a charge or penalty, if any, would be calculated if the borrowers exercise this right.2

In addition, FRFIs are required to provide a description of any components that comprise a formula to calculate a penalty in the event that the borrower exercises the right to repay the amount borrowed before the maturity of the loan.3

Furthermore, this information must be made in language and presented in a manner that is clear, simple and not misleading.4

If a credit agreement for a loan secured by a mortgage is to be renewed on a specified date, the institution must, at least 21 days before the date, provide the borrower with a subsequent disclosure statement that contains the information required to be disclosed by Section 8 or Section 9 of the Cost of Borrowing Regulations (the Regulations).5

Issue

Since the mortgage prepayment penalty review, and in light of many consumers looking to switch or refinance mortgages due to record low interest rates, FCAC has seen a marked increase in complaints from consumers about mortgage prepayment penalty calculations based on IRD. These complaints have led us to identify additional concerns not addressed in the mortgage prepayment penalty review in 2002.

The complaints received generally highlight three issues:

  1. The descriptions of the components to calculate the prepayment penalty are vague and/or difficult to understand.
  2. Some components that are required to calculate the prepayment penalty are missing (e.g. posted rate vs. discounted rate) and/or there is no reference on how to obtain information required for the calculation if it is not known at the time of disclosure.
  3. There appears to be a discrepancy between the prepayment penalty formula that is disclosed to consumers and the system calculation used by some institutions (e.g. estimated IRD vs. actual IRD charge).

Analysis

The regulations require specific disclosure of information consumers need to make sound decisions regarding their financial products and services.

For mortgage prepayment penalties, the requirements to provide the manner in which the penalty is calculated and a description of all the components of the calculation, all presented in clear and simple language, are meant to allow consumers to understand how the mortgage prepayment penalty is arrived at, and to allow them to calculate what the mortgage prepayment penalty might be. With this information, consumers may assess whether mortgage prepayment is right for them in their financial situation.

Failure to provide all the information required, or failure to provide this information in a complete, clear and usable manner, hinder consumers' ability to decide on mortgage prepayment and do not meet the letter nor the intent of the law.

Given the number and scope of the issues we have recently identified regarding mortgage prepayment penalties, we believe that additional clarity for FRFIs is required to help ensure that disclosure is compliant with the regulations and ultimately meets the needs of consumers.

Guidance

The Commissioner of FCAC expects FRFIs to provide consumers with mortgage prepayment penalty disclosure that would allow them to understand and calculate the penalty amount. This would ensure that consumers have the information they require to make informed decisions regarding this significant financial commitment.

In light of this interpretation, FRFIs are expected to incorporate the following into their mortgage prepayment disclosure documents6:

  1. FRFIs must disclose the manner in which a mortgage prepayment charge or penalty is actually calculated.

    This must include disclosure of the formula or a description of the process7 used to arrive at the actual charge or penalty that would be assessed to the consumer. Solely disclosing a formula that produces an estimate would not meet the requirement.

  2. In relation to element #1, FRFIs must provide a description of all the components included in the calculation of the mortgage prepayment penalty.

    The components to be disclosed should be the variables that make up the formula used by the FRFI to calculate the mortgage prepayment penalty.

    For example, if a FRFI uses a present value calculation to calculate the penalty, the components should include variables such as: future value, payment, effective annual rate, number of payments remaining and outstanding balance.

    The description of the components should provide the borrower with an understanding of what each component is and the key characteristics of each of those components.

    The description need not include a fulsome description of the calculation(s) used to arrive at the actual value for each of the components.

    The description of the components should include information to allow consumers to understand how they can obtain the value of each of the components disclosed. This may be achieved in the following ways:

    • by disclosing the numerical value of all components that are known at the time of disclosure—for example, the discount or posted rate
    • by providing a reference to where information regarding certain components could be found if it is not known at the time of disclosure—for example, a reference to a website where the Canada Bond Yield rate could be obtained
    • by providing a sufficient level of detail surroundingthe components of the calculation to allow consumers to arrive at the value—for example, the number of months left until the mortgage maturity date (rounded up or down)
    • by providing a toll-free telephone number that could be called to access FRFI staff who are knowledgeable about mortgage prepayment penalties, and who would be able to orally provide the numerical values for the disclosed components.

  3. Disclosure must be made in language, and presented in a manner, that is clear, simple, and not misleading.

    FRFIs must demonstrate that they have applied the principles of clear language to their mortgage prepayment penalty disclosure. FCAC's Clear Language and Presentation Principles and Guidelines for the Industry can be found at http://www.fcac-acfc.gc.ca/eng/industry/commissioner/guidance/cg-3/index-eng.asp.

    In addition, in order to meet the principles of clear and simple language, FRFIs should also:

    • include an example and/or worksheet to help consumers figure out their own prepayment penalty
    • ensure consistency within and among documents for the same product in terms of prepayment penalty disclosure
    • review English and French documents that contain prepayment penalty disclosure.

  4. Disclosure of a complex calculation must be accompanied by a simplified method to estimate the mortgage prepayment penalty.

    Many FRFIs use mortgage prepayment penalty calculations that are complex and may not be easily presented in a manner that is clear and simple, and therefore are not user-friendly for the average consumer (e.g. a present value calculation).

    In such cases, in addition to the disclosure referred to in elements #1 and #2, the disclosure documentation must also include a simplified method (e.g. estimated IRD) through which the borrower can calculate a reasonable estimate of the prepayment penalty.

    The inclusion of a simplified calculation should meet the following disclosure criteria:

    • Similar to element #2, the disclosure should include all the components of the simplified calculation, a description of those components, and enough information to ensure that consumers can obtain the value for each component to carry out the calculation.
    • It should be clear to the reader that the simplified calculation will only provide an estimate of the prepayment penalty and that the estimate will be an amount higher than the actual penalty calculated by the FRFI.
    • The disclosure should include information that the consumer can contact the FRFI to obtain a more precise mortgage prepayment penalty amount.
    The inclusion of a simplified calculation method that meets the criteria above would be deemed to meet the clear and simple language requirements set out in element #3. Moreover, any worksheets or examples that would be developed by the FRFI to address element #3 can be based on the simplified calculation to facilitate use by consumers.

1. IRD is a charge that may apply if you pay off your mortgage prior to the maturity date, or pay the mortgage principal down beyond the amount of your prepayment privileges.

2. The Bank Act, 452(1)(a)(ii) and 570(1)(a)(ii); The Trust and Loan Companies Act, 438(1)(a)(ii); The Cooperative Credit Associations Act, 385.18(1)(a)(ii); and The Insurance Companies Act, 482(1)(a)(ii) and 601(1)(a)(ii)

3. Cost of Borrowing Regulations, 8(1)(l)

4. Cost of Borrowing Regulations, 6(4)

5. Cost of Borrowing Regulations, 14(1)

6. Initial mortgage disclosure statements and mortgage renewal disclosure statements

7. The disclosure should be brief and concise to allow consumers to understand the manner in which the penalty is calculated.

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Date Modified:
2012-04-13