What is Prepayment Penalty in Canadian mortgages?
Fee charged by lenders for paying off a mortgage before the end of its term. For variable-rate mortgages, typically 3 months interest. For fixed-rate, the greater of 3 months interest or IRD.
Why Prepayment Penalty matters
The penalty can be the largest cost in breaking a mortgage, and on a fixed rate it is often far more than three months of interest. Knowing it before advising a client to refinance or sell prevents an expensive surprise.
Prepayment Penalty example
Worked example
Breaking a $400,000 fixed mortgage mid-term: 3-month interest = $5,500; IRD = $18,000. Penalty = $18,000 (higher of the two).
How brokers use Prepayment Penalty
- Get the exact penalty from the lender in writing before recommending that a client breaks the mortgage. An estimate is not enough.
- Variable-rate mortgages usually carry three months of interest. Fixed-rate mortgages carry the greater of three months of interest or the interest rate differential.
- Compare the penalty with the interest saved over the remaining term before refinancing.
- Consider porting the mortgage or blending and extending as an alternative to paying the penalty.
More questions about Prepayment Penalty
How is a prepayment penalty calculated?
For a variable rate it is usually three months of interest. For a fixed rate it is the greater of three months of interest or the interest rate differential, and the method varies by lender.
Can I avoid a prepayment penalty?
Often you can reduce it by porting the mortgage, making use of annual prepayment privileges, or waiting until the end of the term. Open mortgages have no penalty but carry higher rates.