The 5-Year Rule: How the Interest Act Caps Some Mortgage Penalties
Most borrowers assume their prepayment penalty is whatever their lender's IRD formula produces. For a specific group of mortgage holders, federal law overrides that — capping the penalty regardless of how large the calculation would otherwise be.
The Rule
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 (60-month) mark of that term, your lender cannot charge more than three months' interest as a penalty — no matter what the IRD calculation would otherwise produce.
This is a legal cap, not a lender courtesy. It applies regardless of what your mortgage contract says, because federal law overrides conflicting contract terms in this specific area.
Who This Actually Applies To
Two conditions both need to be true:
- Your mortgage's original term was longer than 5 years — this means 7-year and 10-year fixed terms specifically. A standard 5-year fixed term does not qualify, since the cap only applies to terms longer than five years.
- At least 60 months have passed since your mortgage was advanced — not since you last renewed, but since the original funds were advanced.
If you're on a 7-year fixed term and you're in your sixth year, this cap very likely applies to you. If you're on a standard 5-year term, it doesn't — no matter how long you've held it.
Why This Matters
Without this rule, someone deep into a long fixed term with rates that dropped significantly could face an enormous IRD penalty — the calculation scales with both the rate gap and the months remaining, and a 7- or 10-year term can have a lot of both. The Interest Act cap puts a ceiling on that exposure once you're past the 5-year mark.
A Worked Example
Say you have $350,000 remaining on an original 10-year fixed mortgage at 6%, now in year 7 (so you're past the cap threshold), with 36 months left and a current comparable rate of 3%.
Without the cap, IRD would calculate to: $350,000 × (0.06 − 0.03) × (36 ÷ 12) = $31,500.
With the Interest Act cap in effect, your penalty is instead limited to three months' interest: $350,000 × 0.06 ÷ 4 = $5,250 — a substantial difference.
How to Check If You Qualify
Confirm two things with your lender: your mortgage's original term length (not your current remaining time), and the exact date funds were originally advanced. If both conditions are met, ask your lender directly whether the Interest Act cap has been applied to your penalty quote — it should be, but it's worth confirming rather than assuming.
This is general information, not legal advice. This calculator does not automatically apply this cap, since it depends on your original term length and advance date, which the calculator doesn't collect. If you're on a term longer than 5 years and past your 5-year mark, treat any penalty this calculator shows as a ceiling, and confirm with your lender whether the cap reduces it further.