Mortgage prepayment penalties in Canada: three months' interest vs IRD

What is a mortgage prepayment penalty?

It is a charge for breaking the deal you made for the term. A closed mortgage gives you a rate for a set term, say five years, and in return limits how much you can repay early. The FCAC lists the situations that can trigger a penalty: paying more than your prepayment privileges allow, breaking your contract, transferring your mortgage to another lender, or paying off the whole balance before the term ends. Lenders also call it a prepayment charge or breakage cost.

The most common triggers in real life are selling the home, refinancing to a lower rate or a larger loan, and switching lenders mid-term.

How is three months' interest calculated?

It's your balance times your interest rate, for three months. With $400,000 owing at 5%, three months' interest is $400,000 × 5% × 3 ÷ 12 = $5,000. The FCAC's own example uses $200,000 at 6%: about $3,000.

Some lenders use your contract rate, others a different rate set in the contract, such as prime for some variable mortgages. It is usually charged only on the amount you prepay above your privileges.

How is the interest rate differential (IRD) calculated?

The IRD is the interest the lender gives up because it has to re-lend your money at today's lower rate. In the FCAC's words, the lender works out the total interest left on your term at two rates; the difference is the IRD. Lenders typically use it when your rate is above today's rate for a similar term and you signed less than five years ago.

The FCAC explains that the two rates can be chosen in different ways, and that choice is what makes penalties differ so much between lenders:

• Your rate: your contract rate, or in some contracts the posted rate when you signed.
• The comparison rate: today's rate for a term close to the time you have left, either as offered today, or as the posted rate minus the discount you were given when you signed.

A posted rate is a lender's advertised rate; most borrowers pay a discounted rate below it. When the method subtracts your original discount from today's posted rate, the comparison rate comes out lower, the gap gets bigger, and so does the penalty.

Worked example: the same mortgage, two IRD methods

You owe $400,000 at 5.00% with three years left on a five-year term. You got a 1.99% discount off a posted rate of 6.99% when you signed. Today, the lender's posted rate for a three-year term is 5.49%, and it would lend for three years at about 4.00%.

Assumptions: IRD = balance × rate gap × years left, the simple form the FCAC's example uses. Real calculations follow the balance as it falls and some lenders discount the result to today's value, so a real penalty is usually a little lower than this simple figure; administration and discharge fees are extra. The rates are illustrations, not any lender's rates. On a fixed-rate mortgage you would pay the higher of three months' interest and the IRD your contract uses: $12,000 or $18,000 here.

Fixed vs variable: which penalty applies?

On a fixed-rate closed mortgage, the penalty is usually the higher of three months' interest or the IRD. When rates have risen since you signed, the IRD is small or nil and three months' interest applies; when rates have fallen, the IRD is usually larger.

On a variable-rate closed mortgage, the penalty is usually three months' interest, because your rate already moves with the market. Not always: the FCAC's sample variable-rate disclosure also uses "the greater of" three months' interest or the IRD. Read your own contract, or ask.

Open mortgages and home equity lines of credit have no prepayment penalty.

Is there a limit on penalties after five years?

Yes, for longer terms. Under section 10 of the Interest Act, when a mortgage's term runs longer than five years, an individual can pay it off any time after the fifth anniversary by paying no more than three months' extra interest. It doesn't apply to mortgages given by corporations. On the usual five-year term, the term simply ends at year five, and you can repay without penalty at renewal.

How do I find out my exact penalty?

Ask your lender. The FCAC says lenders must explain how they calculate the penalty and what factors they use; for federally regulated lenders, your annual statement shows how much you can prepay that year without a charge. Banks that follow the industry code also offer a toll-free number and online penalty calculators.

When you call, ask for:

1. The exact penalty in dollars, for a payout on a specific date, in writing. It changes with rates and your balance, so the date matters.
2. How it was worked out: three months' interest or the IRD, the rates used, and whether your original discount was subtracted.
3. Every other charge: administration, discharge or reinvestment fees, and any cash-back you would have to repay.
4. Whether you can use this year's prepayment privilege first, so the penalty applies to a smaller balance.
5. Your options without a payout: porting the mortgage to a new home, blend and extend, or an assumption by a buyer.

The FCAC's advice is plain: ask your lender to explain anything you don't understand.

How can I reduce or avoid a prepayment penalty?

• Use your prepayment privileges. Paying down the most you're allowed each year lowers the balance any future penalty is based on. Unused privileges usually don't carry over.
• Wait for renewal. At the end of the term you can pay off or pay down any amount without a penalty. If you're selling, timing the closing near the term end can save a lot.
• Port the mortgage. If you're buying another home, many mortgages let you take your rate and terms with you.
• Blend and extend. Some lenders let you renew early, blending your current rate with today's, instead of breaking. The FCAC notes that keeping your payment the same after a lower blended rate pays the mortgage off faster.
• Let a buyer assume it, if your mortgage allows, with the lender's approval.
• Choose the right mortgage next time. If you might sell or refinance within the term, a variable rate, a shorter term or an open mortgage can cost less than a big IRD.

When does breaking a mortgage still pay off?

When the interest you save over the rest of your term, plus any other benefit, is more than the penalty and the fees. To compare, work out the interest for the remaining term at your current rate and at the new rate, on the same balance and amortization.

Against a $12,000 IRD, moving to 4.00% saves $11,549: no gain once fees are added. That is by design: the IRD charges you roughly the interest the lender loses, which is roughly what you would save. Against a $5,000 three-months' penalty, the same move is about $6,500 ahead before fees.

So breaking for a lower rate alone rarely pays on a fixed rate with an IRD. It can pay when:

• your penalty is three months' interest, as on many variable-rate mortgages;
• the penalty method uses today's rate, not the posted rate minus your discount, and rates have fallen a lot;
• you're consolidating debt at much higher rates, such as credit cards;
• you need to sell or move and can't port the mortgage, where the penalty is a cost of the move rather than a choice;
• little time is left on the term, so the IRD is small.

A refinance to take out equity has its own tax questions: interest is only deductible when the borrowed money is used to earn income. Our Smith Manoeuvre guide explains the CRA's rules.

Are penalties different in BC and Alberta?

The penalty comes from your contract, so the method depends on your lender, not your province. Banks are federally regulated and follow the FCAC's disclosure rules. Credit unions in BC and Alberta are mostly provincially regulated, so their disclosure rules come from the province, but the same two penalty types are common. Section 10 of the Interest Act applies everywhere in Canada.

This guide is general information, checked against the Financial Consumer Agency of Canada's pages and the Interest Act on 5 Nov 2026. Your contract and your lender's figure decide your real penalty. It isn't financial, legal or borrowing advice for your situation.