How Mortgage Prepayment Penalties Work in Canada
When you break a fixed-rate mortgage before the end of your term in Canada — to refinance, sell, or pay out the mortgage — your lender charges a prepayment penalty. The penalty is typically the greater of:
- 3 months' interest: Three months of interest on your current balance at your contract rate.
- Interest Rate Differential (IRD): The interest the lender "loses" by relending your money at today's lower rate for the remaining term.
Example: $420,000 balance at 6.8% with 30 months remaining and current market rate of 5.4%. The 3-month interest penalty would be about $7,140. The IRD penalty would be about $14,700. The lender charges the higher amount — $14,700.
3-Month Interest Method
The 3-month interest penalty is calculated as: Balance × Annual Rate ÷ 12 × 3. This method is typically used when you have a variable rate mortgage, or when you break your fixed mortgage with a very short time remaining in the term (and the IRD comes out lower).
Interest Rate Differential (IRD) Method
The IRD penalty is calculated as: Balance × (Your Rate − Lender's Current Rate for Remaining Term) × (Months Remaining ÷ 12). This represents the interest income the lender loses by having to relend your money at the current lower rate.
Important: many major Canadian lenders use their posted rate (not your discounted contract rate) in the IRD formula, which significantly increases the penalty. Our calculator uses your contract rate for a baseline estimate; your actual penalty may be higher.
How to Reduce or Avoid Prepayment Penalties
- Wait for your renewal date: At the end of your term, you can change lenders with no penalty.
- Use your annual prepayment privilege: Most mortgages allow 10–20% lump-sum payments annually, penalty-free.
- Choose an open mortgage: Open mortgages have no penalties but typically carry higher rates.
- Break near the end of your term: The shorter the remaining term, the smaller the IRD penalty.
- Port your mortgage: Moving to a new property? Many lenders allow you to port the mortgage with no penalty.
Is Breaking Your Mortgage Worth the Penalty?
Use our Refinance Break-Even Calculator to determine if refinancing at a lower rate saves more than the prepayment penalty costs. In many cases, a large enough rate drop still results in net savings even after paying the penalty.