Why Reverse Mortgage Prepayment Charges Matter
Osman Aziz. September 18, 2020
The Equity Employees Bank Reverse Mortgage is designed to be a long-term solution for retired Canadians. However, we recognize that life changes happen and financial needs evolve. We have created our product with that flexibility in mind.
Reverse mortgages do not have terms like traditional amortizing mortgages. This means that when the interest rate term resets, the borrower cannot repay the mortgage without incurring a charge. Although the reverse mortgage product is designed for longer-term borrowing, some people may use it for shorter periods, but recognize that the prepayment charges will be higher.
Why does a prepayment exist in the first place?
One of the reasons a prepayment charge exists is to offset the internal costs of a lender associated with originating a reverse mortgage (such as administrative, overhead, and other financial costs). These charges are common in most types of mortgages.
Prepayment Charge Comparison
When evaluating reverse mortgage options, prepayment charges should be considered. Below is an example of prepayment charges in practice. The figures below assume a $300,000 reverse mortgage advanced with an interest rate of 3.79% for a 5 year fixed interest rate reset term.
Methodology 1: Equity Employees Bank
|
|
Outstanding mortgage (principal + accrued interest)* |
Prepayment Charge |
Calculation |
Approx. Prepayment Charge Amount* |
| Year 1 |
$ 311,000 |
5 months’ interest |
=311,000*3.79%*(5/12) |
$4,900 |
| Year 2 |
$ 323,000
|
4 months’ interest
|
=323,000*3.79%*(4/12)
|
$4,100
|
|
Year 3
|
$ 336,000
|
3 months’ interest
|
=336,000*3.79%*(3/12)
|
$3,200
|
|
Year 4
|
$ 349,000
|
3 months’ interest
|
=349,000*3.79%*(3/12)
|
$3,300
|
|
Year 5
|
$ 362,000
|
3 months’ interest
|
=362,000*3.79%*(3/12)
|
$3,400
|
Other prepayment methodologies exist which are based on the percentage of principal outstanding. Important to note that larger mortgage amounts with higher interest rates result in a larger principal outstanding balance. When the larger principal outstanding balance is multiplied by the prepayment charge factor, the Prepayment Charge owed will also be larger.
Methodology 2: Other market option
|
|
Outstanding mortgage (principal + accrued interest)* |
Prepayment Charge |
Calculation |
Approx. Prepayment Charge Amount* |
| Year 1 |
$311,000 |
5% of o/u mortgage balance |
$311,000*5% |
$15,600 |
|
Year 2
|
$ 323,000
|
4% of o/u mortgage balance
|
$323,000*4%
|
$12,900
|
|
Year 3
|
$ 336,000
|
3% of o/u mortgage balance
|
$336,000*3%
|
$10,100
|
|
Year 4
|
$ 349,000
|
3 months’ interest
|
=349,000*3.79%*(3/12)
|
$3,300
|
|
Year 5
|
$ 362,000
|
3 months’ interest
|
=362,000*3.79%*(3/12)
|
$3,400
|
Everyone’s mortgage is different, but in this example, a borrower could have saved between $7,000-$11,000 in prepayment costs over the first 3 years by choosing Equity Employees Bank (Methodology 1). You can learn more about our prepayment calculations here.
Prepayment Privileges
To reduce the amount of prepayment charges borrowers can take advantage of prepayment privileges. The Equity Employees Bank Reverse Mortgage also allows flexible prepayment privileges:
- Prepay any interest outstanding once per calendar month
- Prepay up to 10% of outstanding principal once per 12-month period
- After 5 years, prepay up to the entire outstanding balance within 30 days of interest rate reset
- During years 6 to 10, prepay up to the entire outstanding balance with 3 months’ prior written notice
- After year 10, prepay any amount without a charge
When evaluating reverse mortgage options, rates and mortgage amounts are typically the primary considerations. Prepayment terms are often neglected, until the need to prepay the reverse mortgage arises. This could end up costing you thousands. If you have uncertainty regarding how long you envision needing a reverse mortgage, the Equity Employees Bank option may be best for you given our friendlier prepayment terms.