SCREW YOU nuances of IRD (can you solve the mystery?)

Leveraging, renting vs owning, making an investment or buying a home?
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mr_l
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SCREW YOU nuances of IRD (can you solve the mystery?)

Post by mr_l »

[foolishly] A couple payments before breaking my mortgage, I cancelled my prepayment privileges. I signed up for a 30-year amortization period initially, but with generous pre-payment privileges applied to every payment I was on track for a 12-year amortization period. I cancelled these a few payments before breaking the mortgage so that I'd have extra cash on hand for lawyer fees/etc.

That was a stupid decision because...this made the IRD penalty higher.

Here's a clue:
Start of March 2016: discharge penalty quote is $2985.27 based on 3 years at 2.49% [before prepayments cancelled]
Start of April 2016: discharge penalty quote of $3346.18 based on 3 years at 2.49% [after prepayments cancelled]

Why would IRD penalty be HIGHER one month later when the outstanding balance was LOWER?

Is it something to do with the present value of the assumed future payments? Could I have lowered my penalty substantially by providing instructions to increase regular payments by the full pre-payment privileges (increase payment +15%, double-up, +$xx lump sum, switch to accelerated weekly payments) on the last payment before the penalty is calculated?

Customer service told me IRD only depends on difference in interest rate, outstanding mortgage balance, and time left in term....but I'm starting to wonder if they are incorrect. Maybe it also depends on the projected amortization period: shorter projected amortization = lower present value = lower IRD penalty?

OK I'm talking too long here...but anyone else ever try to actually get the IRD details (which seem unethically inaccessible to the customer)?
Just a Guy
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Re: SCREW YOU nuances of IRD (can you solve the mystery?)

Post by Just a Guy »

There used to be a trick you could use to lower your penalty when breaking a mortgage. Let's say you had a 100k mortgage on your house, with a 20% prepayment allowance.

In the old days, you paid off your mortgage, the bank asked for 100k and you paid the penalty on the full amount as the payout was all at one time.

The trick was to get two cheques issued, one for 20k (the maximum prepayment amount) and the other for 80k, and hand in the first saying "I'd like to execute my prepayment option", then hand them the second cheque after the prepayment had been applied. By prepaying, the penalty was now calculated on the 80k instead of the full amount. Banks never told people they could do this (as it made a big difference in their fees).

Many people didn't know this, so wound up overpaying for their mortgage payout.

Several years ago, some lawyers stumbled upon this and launched a class action lawsuit and won. A few people got some money back for overpaying the penalty (most people, in reality, never even heard about the lawsuit).

However, the real fallout was that now, on every mortgage payout, all prepayment amounts are now automatically applied to mortgages and the penalties are calculated as if the maximum prepayment was applied before penalties are calculated.

So, by cancelling your prepayment option, you now pay your penalty based on the entire mortgage amount. Hats why the amounts changed.
mr_l
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Re: SCREW YOU nuances of IRD (can you solve the mystery?)

Post by mr_l »

Just a Guy wrote:the real fallout was that now, on every mortgage payout, all prepayment amounts are now automatically applied to mortgages and the penalties are calculated as if the maximum prepayment was applied before penalties are calculated.
I am not sure if this is true. I asked the Customer Service this specific question and they said no, you have to apply the pre-payment privileges yourself. I complained that this is a little unethical on their part but he said that's the way it is. Also, perhaps to stop this sort of thing, the penalty is calculated 15 days before the date you pay out the mortgage (at least in my case) which means I will not yet have the funds from the completion of the sale of my home yet (so would need to access a short-term loan).

Also, I think my point was more about a surprising way that you can reduce IRD (unconfirmed). Say you pay out the mortgage on April 30 and you are 2 years into a 25 year amortization. Well on your April 15 payment, you tell them you want that payment and all future payments to be doubled from $1000 to $2000. So you pay an extra $1000 on April 15 towards your principal. In the IRD calculation, they assume you pay $1000 extra at every payment for the rest of the amortization period - wow! So this cuts down the amortization period, cuts down present value of your mortgage's future interest, and batta bing batta boom, lowers your IRD penalty MORE than if you had applied a one-time extra $1000 double-up on April 15.

Anyone following me? In other words, giving instructions for "regular double up" on April 15 or "one-time double up" on April 15 will create two different IRDs, even if April 15 is your last payment!
mr_l
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Re: SCREW YOU nuances of IRD (can you solve the mystery?)

Post by mr_l »

OK, I found it. For some reason previously I couldn't find an actual explanation of IRD, again just simplified versions everywhere.

http://www.investorsgroup.com/en/produc ... ent-charge
Here is a formula:
Pv(rRate, Nper, -Pmt, -Fv) – Mortgage Balance = Actual IRD prepayment charge
Pmt: The current monthly principal and interest payment on your mortgage. If the payment frequency is other than monthly, one can calculate the monthly equivalent payment by multiplying weekly payments by 4, and bi-weekly or semi-monthly payments by 2.
So, bigger the "Pmt", smaller the Actual IRD prepayment charge. I guess we'll never know what number the lender uses for "Pmt" (the minimum payment? The most recent payment? The average of the payments in the last 12 months?). But if it is the current "regular payment (including privileges) then that is the opportunity to HACK the penalty - increase it BIG time on your last payment, but ensure you tell you lender to make that the case on every payment going forward (even though you won't have anymore) and badda bing badda boom, you've outsmarted the lender.
brucecohen
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Re: SCREW YOU nuances of IRD (can you solve the mystery?)

Post by brucecohen »

mr_l wrote:OK, I found it. For some reason previously I couldn't find an actual explanation of IRD, again just simplified versions everywhere.
It has been many years since I've looked at this, but I don't think the subject has changed. A generic IRD explanation is almost useless because the calculation is not regulated and lenders vary widely on how they do it and what, if any, surcharges and fees they apply and whether they automatically assume any prepayment allowed. About 30 years ago IIRC the federal govt tabled legislation that would have standardized the IRD calc, but it died on the order paper when an election was called.
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