Mortgage penalties: what it costs to break your mortgage

A mortgage penalty is the fee you pay for ending a closed mortgage before the term is over. You may face it if you sell, refinance, switch lenders or pay off more than your prepayment privileges allow. There is no penalty at the end of the term.

The short version: variable mortgages usually cost three months of interest to break. Fixed mortgages cost the greater of three months of interest and the interest rate differential (IRD), which can be much more.

Three months of interest

For variable-rate mortgages, the penalty is usually three months of interest. For fixed-rate mortgages it is the greater of three months of interest and the IRD.

Example: three months of interest on $400,000 at 4.5% is $400,000 x 4.5% / 4 = $4,500.

The interest rate differential (IRD)

The IRD estimates the interest your lender will lose between now and the end of your term. It is based on the difference between your rate and the lender's current rate for a term matching your remaining time.

Simplified example: $400,000 x 1% rate difference x 2 years remaining = about $8,000.

Why the method matters

Lenders use different methods:

• Current-rate method: compares your rate with the lender's current discounted rate for the remaining term. This usually produces a smaller penalty.
• Posted-rate method: compares your rate with the lender's posted rate minus the discount you originally received. Because posted rates are higher than discounted rates, this can make the result much larger.

Ask your lender which method it uses before you sign, and get the penalty in writing before you break the mortgage. Ask for the penalty calculation, not just the amount.

When you might pay a penalty

• Selling your home before the term ends and not porting the mortgage.
• Refinancing to access equity.
• Switching lenders mid-term for a better rate.
• Paying off more than your prepayment limit.

Ways to reduce the cost

• Use your prepayment privileges: lump-sum payments within the limit do not trigger a penalty.
• Port the mortgage: moving your rate and balance to a new home can avoid a penalty, though you may need to blend in new money at today's rate.
• Blend and extend: some lenders let you blend your old rate with a new one and extend the term, which avoids a penalty but may leave you with a higher rate.
• Time it: if you can wait until near renewal, the penalty shrinks.
• Choose well at the start: a lower rate can come with a harsher penalty, and a variable rate usually has a milder one.

Before you decide

Ask your lender for a written penalty quote, and compare it with the savings from the move. If a new rate saves $200 a month over three years, that is $7,200, and a $6,000 penalty may still be worth it. A mortgage professional can help you model what breaking would cost.

Penalty rules depend on your contract.