How Mortgage Prepayment Penalties Are Calculated in Canada
Breaking a closed mortgage before your term ends — whether to sell, refinance, or switch lenders — usually triggers a prepayment penalty. The rules aren't arbitrary; they follow a standardized method set out by the Financial Consumer Agency of Canada (FCAC). Here's how it actually works.
Two Methods, and Your Lender Charges the Higher One
Every closed mortgage penalty comes down to comparing two numbers:
1. Three months' interest — the simpler calculation, used for all variable-rate mortgages and as the minimum for fixed-rate mortgages:
Outstanding balance × annual interest rate ÷ 4
For example, a $400,000 balance at 5% works out to $400,000 × 0.05 ÷ 4 = $5,000.
2. Interest Rate Differential (IRD) — applies only to fixed-rate mortgages, and estimates what your lender loses by letting you out of a rate they were counting on:
Outstanding balance × (your contract rate − today's comparable rate) × (months remaining ÷ 12)
For a fixed-rate mortgage, your lender charges whichever of the two is larger. Variable-rate mortgages only ever use the three-months'-interest calculation — there's no IRD.
Why IRD Can Be Dramatically Higher
IRD exists because your lender planned to earn interest at your contract rate for your full term. If rates have dropped since you signed, the gap between your rate and today's rate can be significant — and that gap, multiplied across your remaining balance and remaining term, can turn a $5,000 penalty into $15,000 or more.
If rates have risen since you signed, the IRD calculation returns zero (or a negative number, treated as zero) — in that case, the greater-of rule defaults you back to the simpler three-months'-interest amount.
The Comparison Rate Isn't One Fixed Number
This is the part most calculators oversimplify: there's no single "current rate" your lender uses. Big Six banks typically use their posted rate for the comparison, while monoline lenders (mortgage-only lenders without branch networks) typically use a discounted rate. This difference alone can change your penalty by thousands of dollars for an identical mortgage balance and term — which is why our calculator lets you enter your own comparison rate rather than guessing at a single "official" number.
A Legal Cap Worth Knowing About
Under section 10 of the federal Interest Act, if your mortgage was originally written for a term longer than five years and you're past the five-year mark, your penalty is capped at three months' interest — regardless of what IRD would otherwise calculate. This mainly matters for borrowers on 7- or 10-year fixed terms who are past their fifth year.
The Only Way to Know Your Exact Number
Every method above produces a reliable estimate. Your actual penalty depends on your specific lender's methodology, which can vary in ways a general calculator can't fully capture. Federally regulated lenders are required to provide a specific quote if you call and ask — always confirm the real number before making a decision to break your mortgage.
This is general information, not financial advice. Use our Mortgage Penalty Calculator for an estimate based on your specific balance, rate, and term — then confirm the exact figure with your lender.