Penalties for Early Mortgage Repayment (Prepayment)

When you pay off a closed mortgage early, you may face penalties and fees. Penalties are usually the larger cost, so we start there.

What is the difference between a closed and an open mortgage?

Open mortgages let you repay any amount at any time without a penalty. They’re flexible, but because they favour the borrower, they usually carry higher interest rates.

Closed mortgages commit you to keeping the mortgage in place for a set term. Most closed mortgages let you repay a set portion of the original amount each year, often 15% to 20%, without triggering a penalty.

Life is hard to predict. Having a child, taking a job offer you can’t refuse, or a relationship ending can all lead you to sell your home sooner than planned. People often focus on the up-front rate when comparing mortgages and get caught by back-end penalties and fees.

Penalties

If you repay more than your prepayment privileges allow, your mortgage agreement sets out the penalty. Two methods are common: three months’ interest and the interest rate differential (IRD). Lenders usually charge whichever is higher, and the exact formula varies by lender, so check your agreement.

Three months’ interest

For most closed variable- or adjustable-rate mortgages in Canada, the prepayment penalty is usually three months’ interest on the balance being prepaid. One of Canada’s five largest banks describes it the same way. Some lenders calculate it using your mortgage rate, while others use prime. Always confirm the formula in your mortgage agreement and payout statement.

Lowering your balance before payout reduces the amount the penalty is calculated on. The calculation method itself stays the same.

Interest rate differential (IRD)

IRD applies mainly to fixed-rate mortgages and is more complicated. It is roughly the difference between your contract rate and the lender’s current posted rate for a term similar to your remaining term, applied over the time left on the mortgage. Lenders often apply IRD when your rate is above current rates and you signed less than five years ago, but rules differ. Ask your lender how its calculation works.

Exceptions to watch for

Open variable mortgages generally have no prepayment penalty, though their rate is normally higher. Some lenders use prime rather than your contract rate for the three-month calculation. Some credit unions and alternative lenders have non-standard terms, such as minimum penalties or interest-to-maturity charges. Hybrid products can treat the fixed and variable portions differently, and a few terms cap the charge or change the formula near maturity.

Prepaying before payout

If your mortgage allows a lump-sum prepayment, making it before your lender prepares the payout statement can reduce the balance the penalty is based on. Making it about 30 days before the payout statement is probably the safe approach, but confirm with your lender what the conditions are, including the cutoff date and whether recent prepayments count. Make sure you have the funds available without borrowing at a higher rate.

Fees

Fees are charged on payout too, such as discharge, transfer, and reinvestment fees. Many apply whether or not you break the contract, but they can add up, so compare them when choosing a lender. Lenders disclose them in cost-of-borrowing documents, often only at the lawyer’s office. Because lenders and fee schedules vary widely, a mortgage broker can help you compare them.

Talk to your lender

Before you prepay or request a payout, speak with your lender and review your mortgage terms carefully. Look for your annual prepayment privilege, how the penalty is calculated, which rate is used, and when the payout statement is prepared.

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