Prepayment Penalty Disclosure on a Bridge Refinance
A borrower in Calgary holds a closed five-year fixed mortgage at 5.9% with 26 months remaining and an outstanding balance of $412,000. She wants to refinance into a lower-rate product to consolidate $38,000 of credit card debt. Her current lender's prepayment charge is the greater of three months' interest or the interest rate differential (IRD), calculated on the remaining term using the lender's posted rate at origination minus the current posted rate for a comparable term. The posted rate at origination was 6.4%; the current posted three-year rate is 4.1%. The broker also notes the borrower's total debt service ratio would rise to 44% if the consolidation proceeds, and her lender's guideline caps TDS at 44%. The borrower is adamant the refinance saves money and wants the file submitted today.
1. Estimate the prepayment charge under both methods and identify which applies. Show your arithmetic and state any assumption you must flag to the borrower.
Read the worked answer
Three months' interest: $412,000 × 5.9% ÷ 12 × 3 = $6,077. IRD: the rate difference is 6.4% − 4.1% = 2.3%; applied to the balance for the remaining 26 months: $412,000 × 2.3% ÷ 12 × 26 ≈ $20,531. The greater charge is the IRD at roughly $20,500, over three times the three-month figure.
Assumption to flag: the lender's actual IRD formula may discount the difference or use a posted rate for a term closest to the remaining 26 months rather than a full three-year term, so the real number could differ. The broker must obtain the lender's written payout statement before quoting a figure, and must not present the $20,500 as final. The key judgement is that the headline rate drop can be erased by the penalty - the borrower should compare the penalty plus new closing costs against the interest saved over the remaining term.
2. The TDS lands exactly at the 44% cap. What should the broker do before submitting, and why is 'it fits exactly' a weak position?
Read the worked answer
At exactly 44% the file sits on the guideline limit with no cushion, so any verification variance - a higher credit card balance, a property tax reassessment, a missed overtime figure - pushes it over and triggers a decline or a resubmission delay. The broker should verify balances directly rather than relying on stated figures, confirm the amortization and stress-test qualifying rate used by the lender, and consider whether paying down part of the $38,000 consolidation reduces TDS enough to leave room. Presenting the file as compliant without stress-testing the inputs is a conduct risk, not just a credit risk: the broker is representing the borrower's position as accurate. The broker should also document the calculation and tell the borrower plainly that the file is at the ceiling.
3. The borrower insists on submitting today despite the penalty finding. How should the broker respond?
Read the worked answer
The broker should not simply comply. The duty is to give the borrower the information needed to make an informed decision, in writing, before the commitment is signed. That means documenting the estimated penalty, the interest saved over the remaining 26 months, and the net position - which may well be negative. If the borrower still wants to proceed after seeing the comparison, the broker can submit, but should record that the disclosure was made and the borrower chose to proceed. Submitting without disclosing a known $20,000 cost because the client was impatient would be a failure of the disclosure and suitability obligations, and would be difficult to defend if the borrower later complained.