Prepayment Penalty

A prepayment penalty is the charge a lender applies when you break a mortgage early or prepay beyond the privileges written into your mortgage contract. It is not a surprise fee — the formula sits in the terms you sign — but the amount can vary widely depending on your rate, your remaining term, and the lender's method of calculation.

How lenders calculate the charge

Most closed Canadian mortgages charge the greater of two amounts:

Three months' interest — based on your current balance and contract rate. This is the common minimum floor on both fixed-rate and variable-rate mortgages.
Interest rate differential (IRD) — a comparison between your contract rate and the lender's rate for a term similar to the time left on your mortgage. It generally applies to fixed-rate mortgages and can be far larger than three months' interest.

Lenders do not all use the same IRD formula. Some calculate it from posted rates, others from discounted rates, so two institutions can quote very different penalties on the same mortgage balance. Variable-rate mortgages are usually charged three months' interest only, though the exact wording is in your contract.

What triggers a penalty

A charge typically applies when you:

Pay off the entire balance before the term ends, such as after selling your home.
Refinance into a new mortgage with the same lender before maturity, breaking the existing term.
Prepay more than your annual privilege permits — commonly a set percentage of the original principal, plus any allowed increase in regular payments.
Move the mortgage to another lender mid-term, unless your contract permits a switch without charge.

Prepaying inside your prepayment privilege costs nothing. Read that privilege closely: exceeding it can trigger the charge, and some contracts apply the penalty to the portion above the limit.

Why it matters to borrowers

For anyone comparing mortgages, the penalty is part of the true cost of borrowing. A lower advertised rate can end up more expensive if it carries a punitive IRD formula. Because lenders charge the greater of three months' interest and the IRD, the larger figure is what you owe.

If you might sell, refinance, or relocate during the term, estimate the penalty before you sign rather than after. In some cases the charge is reduced when you renew or take a new term with the same lender, but that depends entirely on the contract — confirm the current terms in writing. The penalty guide explains how the calculation works step by step.

Frequently asked questions

How is a mortgage prepayment penalty calculated in Canada?

On most closed mortgages the lender charges the greater of three months' interest or the interest rate differential (IRD). Three months' interest is based on your balance and rate; the IRD compares your rate with the lender's current rate for a similar remaining term. The formula and which rates it uses are set out in your mortgage contract.

Is it cheaper to break a variable-rate or a fixed-rate mortgage?

Variable-rate mortgages are typically charged three months' interest only, which is often smaller than a fixed-rate IRD penalty. Fixed-rate mortgages can carry a much larger charge, especially when your contract rate is well above current rates. The exact amount always depends on your balance, rate, and the terms in your contract.

Can I avoid a prepayment penalty?

You can usually avoid it by staying within your annual prepayment privilege, waiting until the term ends, or choosing an open mortgage if you expect to pay off the balance early. Some lenders reduce or waive the charge when you renew or refinance into a new term with them. Confirm the details in writing before you act.