Consumers overlook prepayment terms in their mortgage agreement resulting in unexpected penalties

Key lesson

Before signing a mortgage  agreement, consumers should take the time to read through their mortgage documents.

Information about prepayment penalties is normally written in plain language and found in the mortgage agreement. Paying off a mortgage early – for example, by selling a house before the term of the mortgage ends – can result in thousands of dollars in penalties, and sometimes consumers are not aware of this until it’s too late. Not all prepayment penalties are calculated the same way – how the penalty is calculated varies among different lenders and different types of mortgages. It is the consumer’s responsibility to understand the terms and conditions of the mortgage agreement they sign.

Purchase of new home results in paying off existing mortgage early

In July 2016, Mr. and Mrs. Z purchased a home and obtained a five-year mortgage for approximately $430,000 from their bank. They had been customers with the bank for over 40 years. During that time, they had held a number of mortgages.

In June 2018 – not quite two years into their five-year mortgage agreement –  Mr. and Mrs. Z sold their home and paid the mortgage loan in full. However, to their surprise, the bank charged them a prepayment penalty of $3,000 – an amount equal to three months’ interest. Mr. and Mrs. Z had never been charged a prepayment penalty before.

They contacted the bank to complain that its terms regarding prepayment penalties had not been properly disclosed. They wanted the bank to reimburse them for the penalty because they felt it was unfair – they were valued customers of the bank and the bank could now re-lend the money from their mortgage at a higher interest rate. Mr. Z admitted to not reading through his mortgage documents, but he still felt that the bank should reimburse him. Mr. and Mrs. Z also said that, while they were willing to pay an administrative fee, it should only be $500. 

Bank points to mortgage documents

The bank told Mr. and Mrs. Z that the annual mortgage statements that had been sent to them clearly detailed the prepayment options and penalties. As a result, the bank refused to reimburse the amount of the penalty because it had provided the appropriate disclosures and mortgage documents.

Unsatisfied with the bank’s response, Mr. and Mrs. Z came to OBSI to review their case. 

Our findings

During our investigation, we found that the bank was within its rights to charge Mr. and Mrs. Z the $3,000 prepayment penalty because:

• the penalty and how it would be calculated were clearly disclosed in Mr. and Mrs. Z’s mortgage documents and met regulatory requirements;
• by signing the mortgage documents, Mr. Z agreed to be bound by the terms of the mortgage agreement;
• the bank was under no legal or regulatory obligation to reimburse any fees or charges because Mr. and Mrs. Z did not read the agreement, and were therefore unaware of the conditions they had agreed to;
• there were no other circumstances to support Mr. and Mrs. Z’s claims that the $3,000 prepayment penalty charged to their mortgage should be reimbursed.

Based on the findings of our investigation, we found no basis for recommending compensation to Mr. and Mrs. Z.