Mortgage Prepayment Penalties: How They Work and What They Cost

Mortgage Education

By Charandeep Deol, Mortgage Agent Level 2 · Updated October 2026 · 5 min read

If you pay off or break your mortgage before the term ends, for example to sell or refinance, you may owe a prepayment penalty. Knowing how it's calculated before you sign can save a lot of stress.

Three months' interest

Many variable-rate mortgages charge three months' interest on the outstanding balance.

Example: balance of $500,000 at 4.50%. $500,000 × 4.50% ÷ 4 ≈ $5,625.

Interest rate differential (IRD)

Fixed-rate mortgages usually charge the greater of three months' interest or the IRD. The IRD compares your contract rate with a rate the lender would charge today for a term matching your remaining time. In simplified form:

IRD ≈ balance × (your rate − comparison rate) × remaining years.

Simplified example: $500,000 balance, a 1.00% difference and 2 years remaining → about $10,000. Real calculations differ.

Why IRD formulas differ

There's no single industry formula. Some lenders compare against their discounted rates; others, including some large banks, use posted rates, which can produce a larger penalty. The Financial Consumer Agency of Canada encourages borrowers to ask how the penalty is calculated.

Ways to reduce penalty risk

• Ask for the formula in writing before you sign.
• Consider your plans. If you might move or refinance, a shorter term, variable rate or portable mortgage could suit you better.
• Use prepayment privileges. Most mortgages allow extra payments each year without a penalty up to a limit.
• Check portability. Some mortgages can move with you to a new home.
• Ask about blend-and-extend if you want a new rate mid-term.

Before you break a mortgage

Get an exact penalty quote from your lender and compare it with the savings from the new mortgage. Our guide on refinancing explains how to weigh the costs. Also see fixed vs. variable.

This article is general information, not personalized mortgage, legal, tax or financial advice. Rules, rates and eligibility change and depend on your circumstances and lender criteria. Confirm details before you make decisions.