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Mortgage Confusion

Confused about Mortgages, so are some journalists!

Some Canadians are confused about mortgages. There are many reasons why this is so. There is hope however. The Ontario educational system has improved tremendously concerning these financial matters in the last decade. Browse a current grade 11 Mathematics text book and you will be thoroughly impressed. However, education does not stop upon high school graduation, it is a continuing journey. What are consumers to believe if they are exposed to confusing newspaper articles. An example of shoddy journalism in a Canadian newspaper today (April 14th 2004) concerning mortgages illustrates my point.

The newspaper article (Time is now to talk about mortgages) highlights twelve areas of concern a borrower should keep in mind when comparison shopping for a mortgage. They are listed below exactly, as printed in the newspaper.

1 “The total of your payments at the end of the term”
2 “Of that total, how much you will have paid in interest charges at the end of the term”
3 “Your annual interest rate”
4 “The real annual interest rate or annual percentage rate (APR), which includes the extra charges related to your mortgage (such as inspection and appraisal fees, broker fees) that may be added by the lender.
5 “The date on which you will start being charged interest”
6 “The amount of your payments and when they are due”
7 “The fact that your payments will be applied first to interest and other charges, and then to the outstanding principal”
8 “The optional services (such as disability or life insurance) you agree to take, how much they cost and the penalty if you decide to cancel those services”
9 “How the penalties will be calculated if you decide to repay your mortgage before maturity”
10 “The charges that may apply if you don’t keep up your payments for any reason and the mortgage goes into default”
11 “Whether there were any brokers fees paid by the institution to a broker, included in the amount lent to you”
12 “Whether you will have to pay a fee to discharge the mortgage after you pay it off or when the financial institutions interest in your home ends”

What was painfully obvious was the authors apparent lack of understanding of the workings of an amortization schedule. The first seven areas of concern could be addressed by simply asking a lender for an amortization schedule. The amortization schedule could be given to an accountant to verify, if one was not comfortable with the mathematics. Instead of suggesting to ask for an amortization schedule, which the journalist described in detail, the article went on to plug a newly created Federal Government web site and the authors own web site as a source of enlightenment. The web site plugs I can understand, as I plug this web site at every opportunity. What I don’t understand is her apparent misunderstanding of an amortization schedule and current financial terminology.

Item #4, “the real annual interest rate”, caught my attention because the acronym APR is American terminology. The appropriate terminology is effective interest rate (EIR) and Total Cost of Borrowing (TCOB). The EIR is greater because of the type of compounding whereas the TCOB (used by Ontario mortgage brokers) is greater because of the total of all the fees involved in closing a mortgage.

Item #5 The day you sign the mortgage (advance date) contract is the day you are advanced the money and the interest clock starts ticking. This is shown on an amortization schedule.

Item #7, “The fact that your payments will be applied first to interest…” demonstrates a misunderstanding of how mortgages and loans are calculated. The moment you sign and are advanced money an interest clock starts ticking. The moment you make a payment the interest clock stops ticking and you owe the lender the interest payment for the use of the money. The payment minus the interest is applied towards paying down the principal and the clock starts ticking again. Its that simple! The fact that you pay interest for the use of a lenders money should not come as a shock to anyone.

Item #9 The names of the “penalties” are well known vernacular and should have been used in the article. Its not a big secret. There are two types of penalties commonly used. Premature exit from a mortgage term costs you the Three month interest penalty or the Interest Rate Differential (IRD) whichever is greater. Most lenders today are writing the premature renewal penalty into the mortgage agreement.

Item #10 is also very simple. If a payment is missed the interest owing is added to the outstanding balance (negative amortization). There is no need to sift or surf through pages on a web site to find out the answer to that question.

Item #11 again demonstrates a very basic misunderstanding. If you needed to borrow $100,000 for a mortgage and you were given an amortization schedule showing an initial principal amount of $100,500 I think the average person would be inclined to ask their lender what the extra $500 was for?

Item 12 was new and refreshing. Most Lenders today charge a close out fee. Who can forecast 25 years down the road if the closing out fee will be the same or if you will even be with the same lender. The ending of item 12 left me chuckling a bit. “… when the financial institutions interest in your home ends”. Sounds like a scare tactic, implying unless you go to these two web sites you may never really know when you own your home. The land registry office in Ontario will mail you the deed to your home once the Lender furnishes them with the paperwork. It is usually more convenient to let the Bank file the close out papers at the Land Registry office for you for a $70 fee. The thought of standing in line and missing possibly a half a days pay to register paperwork will probably convince most people, to forgo that thrill!

Canadians need a consistent set of financial rules and terminology to be used by all lenders. Consistent regulations and terminology are essential in dealing with the money lending market. The Canada Interest Act (1900) and the overlapping Federal and Provincial band aid fixes since then are totally inadequate today! Legislating that all lenders provide amortization schedules within 72 hours of a mortgage closing (just like Ontario Mortgage Brokers) is a good start. It will not help the world unfold according to a devine plan but it will help ensure that borrowers see the light! (humour!)..

Ron Cirotto




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