Breaking your mortgage early is one of the most expensive mistakes Canadians make—often costing $10,000 to $30,000 or more. Understanding how penalties work before you sign could save you a small fortune.
How Mortgage Penalties Work
When you break a fixed-rate mortgage before its term ends, you pay a penalty to compensate the lender for lost interest income.
The Two Penalty Calculations
Lenders use the higher of:
- Three months' interest - Simple calculation based on your current rate
- Interest Rate Differential (IRD) - Complex calculation that's often much higher
| Calculation | Formula | Typical Amount |
|---|---|---|
| 3 months' interest | Balance × Rate × 3/12 | $3,000 - $6,000 |
| IRD | Balance × Rate Difference × Remaining Term | $10,000 - $40,000+ |
Interest Rate Differential Explained
IRD compensates the lender for the difference between your rate and current rates:
Example Calculation:
- Original rate: 5.00%
- Current rate for remaining term: 3.50%
- Difference: 1.50%
- Remaining balance: $400,000
- Time remaining: 3 years
IRD Penalty: $400,000 × 1.50% × 3 = $18,000
Why IRD Varies So Much
Different lenders calculate IRD differently:
| Lender Type | IRD Calculation | Penalty Level |
|---|---|---|
| Big banks | Posted rate vs current posted | Highest |
| Credit unions | Contract rate vs current | Medium |
| Monolines | Contract rate vs current | Lowest |
Critical insight: A mortgage with a big bank could have an IRD penalty 3-4× higher than the same mortgage with a monoline lender.
Understand Your Penalty Before Signing
Get pre-approved with our team and we'll help you understand penalty implications of each lender's mortgage contract.
Variable Rate Penalties
Variable rate mortgages typically have much lower penalties:
| Rate Type | Penalty | Example ($400K balance, 5% rate) |
|---|---|---|
| Variable | 3 months' interest only | $5,000 |
| Fixed | IRD (if higher) | $15,000 - $30,000 |
Strategy: If you think you might break early, variable rate flexibility can be worth the potential rate premium.
Common Reasons for Breaking Mortgages
Life Events
- Divorce or separation
- Job relocation
- Growing family needs more space
- Downsizing after kids leave
- Financial hardship
Financial Opportunities
- Rates drop significantly
- Debt consolidation makes sense
- Accessing home equity
- Investment opportunities
When Breaking Makes Sense
Calculate the math:
| Factor | Amount |
|---|---|
| Penalty cost | $15,000 |
| Rate savings over 5 years | $25,000 |
| Net benefit | $10,000 |
Breaking makes sense when savings exceed costs. Our team can run this analysis for you.
Strategies to Minimize Penalties
1. Port Your Mortgage
If you're moving, you may be able to transfer your mortgage to the new property without penalty.
Porting requirements:
- Must qualify at new property
- Typically 30-120 day window
- May be able to increase mortgage amount
2. Blend and Extend
Instead of breaking, blend your current rate with a new rate for an extended term.
Best for: Accessing additional funds while avoiding penalty
3. Wait It Out
If you're within 6-12 months of renewal, waiting may save thousands.
Calculate: Penalty cost vs. interest cost of waiting
4. Choose Flexible Products Initially
- Variable rate mortgages (3 months' penalty)
- Open mortgages (no penalty, higher rate)
- Shorter terms (less time to break)
Lender Comparison: Penalty Policies
| Lender Type | Penalty Fairness | Notes |
|---|---|---|
| Big 5 Banks | Lower | Use posted rate for IRD |
| Credit Unions | Medium-Fair | Often use contract rate |
| Monoline Lenders | Fairest | Contract rate, transparent |
| Private Lenders | Varies | Read contract carefully |
What to Ask Before Signing
- How is the IRD calculated?
- What rates are used (posted vs. contract)?
- Can I port to a new property?
- Is blend-and-extend available?
- What are the maximum prepayment privileges?
FAQ
Q: Can I negotiate my penalty?
A: Sometimes. If refinancing with the same lender or in financial hardship, some lenders will reduce or waive penalties.
Q: Is the penalty tax-deductible?
A: Not for your primary residence. For rental properties, penalties may be deductible as a financing cost.
Q: What if I sell my home and buy another?
A: You may be able to port your mortgage to avoid the penalty. Timing and qualification rules apply.
Q: How do I find out my exact penalty?
A: Contact your lender directly for a penalty quote. They're required to provide this information.
Q: Are there mortgages with no penalties?
A: Open mortgages have no penalties but charge higher rates. Some lenders offer "no-frills" products with reduced penalties.
What's Next
Don't sign a mortgage without understanding the penalty implications. Contact our team and we'll help you choose a lender whose penalty policies match your life situation.
Ready to Get Started?
Contact us today for personalized mortgage advice and competitive rates.
