Mortgage Prepayment Penalty: 3 Months vs IRD

Breaking a closed mortgage before the term ends almost always costs money, and the number on the payout statement surprises a lot of people. The difference between a modest charge and a five-figure one usually comes down to which formula your lender uses and what rate it plugs in. This guide explains how a mortgage prepayment penalty is worked out, what your lender has to tell you, and the legitimate ways to pay less. The rules come from the Financial Consumer Agency of Canada (FCAC) and the federal Interest Act.

When you pay a mortgage prepayment penalty

FCAC describes a prepayment penalty as a charge you pay when you pay more than the allowed additional amount toward your mortgage, or when you break your mortgage contract before the term ends. It can be triggered when you:

pay down more than your contract's prepayment privileges allow
move the mortgage to another lender before maturity
pay the whole mortgage off before the end of the term
sell your home and pay the loan off from the proceeds

Open mortgages generally let you prepay without a penalty, which is the main thing you pay for when you choose one. Our open vs closed comparison covers that trade-off. Once your term matures you can pay off or move the balance without a prepayment charge, which is why timing matters so much.

The two common formulas

FCAC says the penalty on a closed mortgage is usually the higher of two amounts:

Three months' interest on the balance you still owe.
The interest rate differential (IRD), which measures the interest the lender loses because it has to re-lend your money at today's rates for the rest of your term.

The IRD only bites when your contract rate is higher than the rate the lender can get today for a similar term. When rates have risen since you signed, the IRD often works out to little or nothing, and three months' interest is the bigger number.

FCAC's own example

Input	Value
Balance owing	$200,000
Your contract rate	6%
Time left in the term	36 months
Lender's current rate for a 3-year term	4%
Three months' interest	$3,000
IRD (2% × $200,000 × 3 years)	$12,000
Penalty charged (the higher)	$12,000, plus any administration fees

The rates in FCAC's example are illustrative, and so are ours below. We don't quote or forecast rates.

Why two lenders can charge very different IRDs

The IRD looks simple, but FCAC points out that lenders choose which rates go into it. For the rate you are paying, a lender may use your actual discounted rate or the posted rate from when you signed. For the comparison rate, it may use its current posted rate for a similar term, or that posted rate minus the discount you originally received.

A hypothetical showing the effect of the discount

Say you signed at 5.00% when the lender's posted rate was 6.50%, a 1.50-point discount. Three years remain, the balance is $300,000, and the lender's current posted rate for a 3-year term is 5.00%.

Method 1, your rate vs current posted: 5.00% − 5.00% = 0. The IRD is $0, so you would pay three months' interest: $300,000 × 5% ÷ 4 = $3,750.
Method 2, your rate vs current posted minus your discount: 5.00% − (5.00% − 1.50%) = 1.50%. The IRD is $300,000 × 1.50% × 3 = $13,500.

Same borrower, same balance, same day, and one method costs more than three times the other. That is why "what is my penalty?" can only be answered with your own contract and your lender's own figures. It is also why the penalty clause is worth reading before you sign, not only when you want out.

What your lender has to tell you

For federally regulated lenders, FCAC's rights pages set out what you are entitled to:

Your mortgage agreement must show prepayment privileges, charges and other key details in a single, prominently displayed information box.
The lender must tell you how it will calculate prepayment charges and describe the elements it uses.
When you confirm you want to repay, the lender must give you a written statement of the applicable prepayment charge and a description of how it calculated it.
FCAC notes that banks following the Canadian Bankers Association code provide online calculators to estimate the charge and a toll-free number where staff can calculate it on request.

Ask for the written figure before you sign anything with a new lender, and ask whether it is valid until a certain date. Balances and rates change, so the number moves.

The five-year rule in the Interest Act

For mortgages with a term longer than five years, section 10 of the federal Interest Act says that once five years have passed, the borrower can pay off the mortgage with three months' further interest in lieu of notice, and no further interest can be charged. The section has exceptions, including mortgages given by a corporation. If you have a 7- or 10-year term and are past year five, raise this with your lender.

Other costs of breaking a mortgage

The penalty is not the only charge. FCAC lists administration fees, appraisal fees, reinvestment fees, a mortgage discharge fee, and repaying any cash-back you received when you took the mortgage. On discharge fees, FCAC notes that some provinces regulate the maximum a lender can charge and suggests asking a new lender whether it will cover discharge costs. Add every item up before you decide a lower rate somewhere else is worth it.

Ways to reduce a mortgage prepayment penalty

Use your prepayment privileges first. FCAC suggests making the most of the amount you are allowed to prepay each year. Paying down the balance before you break shrinks the base the penalty is calculated on.
Wait for maturity, or get closer to it. FCAC lists waiting until the end of the term as an option. With an IRD, fewer months remaining means a smaller number.
Port the mortgage if you are moving. A portable mortgage can move to your new home; see our guide to mortgage porting.
Ask about blend and extend. FCAC explains that some lenders let you extend your term early without a prepayment penalty, blending your current rate with the new term's rate. In FCAC's example, $200,000 at 5.5% with 24 months left, extended into a 5-year term at 4%, blends to 4.6%. Administration fees may apply.
Consider whether a buyer can assume it. FCAC says most fixed-rate mortgages are typically assumable with lender approval.
Ask about hardship relief. FCAC's guideline on mortgages in exceptional circumstances lists waiving prepayment penalties among the relief measures banks may offer borrowers at risk.

If you are weighing a refinance or a switch mid-term, our Richmond refinance page explains how we compare the cost of breaking against the savings. Blue Sky Mortgage Group is a licensed BCFSA mortgage brokerage in Richmond, and you can send us your payout statement to go through it line by line.

Common questions about a mortgage prepayment penalty

How is a mortgage prepayment penalty calculated in Canada?

On a closed mortgage it is usually the higher of three months' interest on the balance you still owe or the interest rate differential (IRD). FCAC's example: on $200,000 at 6% with 36 months left and a current 3-year rate of 4%, three months' interest is $3,000 and the IRD is $12,000, so the penalty is $12,000.

Why is my penalty so much higher than my friend's?

Lenders choose which rates go into the IRD. Some use your actual discounted rate against today's posted rate; others subtract your original discount from today's posted rate, which makes the gap, and the penalty, larger. The balance, time left and contract wording all matter too.

Does my lender have to tell me how the penalty is calculated?

Yes, for federally regulated lenders. Your agreement must show prepayment charges in an information box, the lender must describe the elements it uses, and when you confirm you want to repay it must give you a written statement of the charge and how it was calculated.

Is there a cap on the penalty after five years?

For terms longer than five years, section 10 of the Interest Act lets you repay after five years with three months' further interest in lieu of notice. The section has exceptions, including mortgages given by a corporation.

How can I avoid a prepayment penalty?

Wait until your term matures, use your annual prepayment privileges, port the mortgage to your next home, ask about a blend and extend, or see whether a buyer can assume the mortgage. Each depends on your contract and lender approval.

Rules as of October 2026, from FCAC (prepayment, breaking and rights pages modified October 15, 2025; discharge page September 25, 2025; exceptional-circumstances guideline September 25, 2025) and the Interest Act, s. 10.

This is general information, not financial advice. Speak to a licensed mortgage professional about your situation.

Your Mortgage Prepayment Penalty