*Disclaimer: Please note that the calculation results are estimates based on our most up-to-date information sourced from lenders’ publicly stated methodology and first-hand accounts. This information is subject to change and does not include special offers or any discharges, registration, reinvestment or transfer fees.

A guide to mortgage penalties

What is a prepayment penalty on a mortgage?

A mortgage prepayment penalty is a fee your lender may charge if you pay off your mortgage, refinance, or otherwise break your mortgage contract before the end of its term. The amount of the penalty depends on your mortgage details and your lender's method for calculating penalties. This fee compensates the lender for the interest they lose when your mortgage is paid off early. 

When do you pay a mortgage penalty?

If you have a closed mortgage, you'll typically pay a prepayment penalty in the following situations:

• • Selling your home: If you sell your home before your mortgage term ends, you'll usually need to pay a prepayment penalty unless you transfer (port) your mortgage to a new property or qualify for another exception offered by your lender.
  • Refinancing your mortgage: Refinancing involves replacing your existing mortgage with a new one, often to access home equity, consolidate debt, or secure a better interest rate. If you refinance before your mortgage term expires, you'll have to pay a prepayment penalty.
  • Switching lenders before renewal: If you move your mortgage to a different lender before your current term ends, you'll be charged a prepayment penalty for breaking your mortgage. However, if you switch lenders at renewal, you won't pay a prepayment penalty because your mortgage term has ended.
  • Paying off your mortgage early: If you pay off your mortgage in full before the end of your term, you'll usually incur a prepayment penalty unless you have an open mortgage or your mortgage agreement allows you to do so without a penalty.
  • Exceeding your prepayment privileges: Most closed mortgages allow you to make extra lump-sum payments or increase your regular mortgage payments each year without incurring a penalty. These prepayment privileges are subject to limits set by your lender, such as 10% to 20% of your original mortgage balance annually. If you exceed those limits, you'll have to pay a prepayment penalty on the excess amount.

How much does it cost to break a fixed mortgage?

The cost of breaking a fixed-rate mortgage varies depending on your lender and the terms of your mortgage. In most cases, you'll pay the greater of three months' interest or the Interest Rate Differential (IRD). Because the IRD often results in a much larger penalty, breaking a fixed-rate mortgage can cost anywhere from a few thousand dollars to tens of thousands of dollars.  While every lender has its own formula, the IRD is generally based on four key factors:

• Your remaining mortgage balance
• The interest rate on your existing mortgage
• The amount of time left in your mortgage term
• The lender's current rate for a mortgage with a similar remaining term

How to calculate the IRD penalty?

Let's look at the process of how the IRD is calculated:

1. Your lender determines your remaining term. For example, if you have two years left on your five-year mortgage, your lender will compare your rate to the rate it currently offers for a two-year fixed mortgage (or the closest equivalent term).
2. Your lender calculates the difference between the two rates. If your current mortgage rate is higher than today's comparable rate, there is an interest rate differential. For example if your current mortgage rate is 5.50% and the current comparable lender rate is 3.75%, then the interest rate differential would be 1.75%
3. The lender applies the rate difference. The difference is applied to the remaining mortgage balance over the time left in your term. The larger your remaining balance and the longer the time remaining on your mortgage, the higher the IRD penalty is likely to be.

Finally, the lender compares the IRD with three months' interest. Your prepayment penalty is typically whichever amount is greater. Keep in mind that there isn't one standard IRD formula across all Canadian lenders. Some lenders use their posted mortgage rates, while others use discounted rates or proprietary calculations. As a result, two borrowers with similar mortgages could pay different penalties depending on their lender.

How much does it cost to break a variable-rate mortgage?

Breaking a variable-rate mortgage is generally less expensive than breaking a fixed-rate mortgage. In most cases, your lender will charge a prepayment penalty equal to three months' worth of interest on your remaining mortgage balance. The exact amount depends on your outstanding mortgage balance and your current interest rate. For example, if you have a $500,000 variable-rate mortgage with an interest rate of 5.95%, your three-month interest penalty would be approximately $7,438.

Although the penalty is usually lower than for a fixed-rate mortgage, it's still important to compare the cost of breaking your mortgage against the savings you expect from refinancing, switching lenders, or paying off your mortgage early.

Is it worth exiting a mortgage early?

Breaking your mortgage may make sense if you're able to secure a significantly lower interest rate through refinancing, need to access your home equity, consolidate high-interest debt, or are selling your home before your mortgage term ends. In these situations, the long-term savings or financial flexibility may exceed the cost of the penalty. However, if your penalty is substantial, particularly for a fixed-rate mortgage, it may be more cost-effective to wait until your mortgage comes up for renewal.  

Ways to reduce or avoid a mortgage penalty

If you have an open mortgage, you can pay off or break your mortgage at any time without paying a prepayment penalty. With a closed mortgage, however, you'll have to pay a penalty if you end your mortgage before the end of its term. There are a few situations where you may be able to avoid or reduce the cost:

• Wait until your mortgage renews: Once your mortgage term ends, you can pay off your mortgage, switch lenders, or renew without paying a prepayment penalty.
• Port your mortgage to a new property: If your mortgage is portable, your lender may allow you to transfer your existing mortgage, interest rate, and remaining term to a new home instead of breaking your mortgage. This can help you avoid a prepayment penalty, provided you meet your lender's eligibility requirements.
• Maximize your prepayment privileges: Most closed mortgages let you make additional lump-sum payments or increase your regular mortgage payments each year up to a specified limit without a penalty. Reducing your outstanding mortgage balance before breaking your mortgage can lower the penalty you'll pay.
• Look for lender incentives: If you're refinancing or switching lenders, some lenders may offer cash-back promotions or cover certain switching costs. While these incentives don't eliminate your prepayment penalty, they can help offset the overall cost of breaking your mortgage.