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How Mortgage Penalties Are Calculated in Canada

Updated

When you break a closed mortgage before the end of its term, the lender charges a prepayment penalty (also called a prepayment charge or breakage cost). This page explains the two calculations lenders use, how the comparison rate changes the result, and the Interest Act limit that applies after 5 years. It is part of the refinancing and home equity hub.

In one sentence: Breaking a closed mortgage, paying it off early or prepaying more than your privileges allow usually costs the higher of 3 months' interest and the interest rate differential (IRD) on a fixed rate, and typically 3 months' interest on a variable rate; your mortgage contract sets the exact method and comparison rate, and a federally regulated lender must tell you how it calculates the penalty.

When a penalty applies

According to the Financial Consumer Agency of Canada (FCAC): A penalty can apply when you prepay more than your prepayment privileges allow, break the contract, move the mortgage to another lender before the end of the term, or pay it off before the end of the term, including when you sell; an open mortgage can be prepaid without a penalty.

The penalty is not the only cost. Breaking the contract can also cost administration, appraisal and reinvestment fees and a discharge fee, and you may have to repay any cash back you received.

The rule in full

  • A penalty can apply when you prepay more than your prepayment privileges allow, break the contract, move the mortgage to another lender before the end of the term, or pay it off before the end of the term, including when you sell; an open mortgage can be prepaid without a penalty.
  • On a fixed-rate mortgage the penalty is usually the higher of 3 months' interest on what you still owe and the interest rate differential (IRD).
  • The lender usually uses the IRD when your mortgage rate is higher than its current rate and you signed your current contract less than 5 years ago.
  • The IRD is the difference between the interest left on your term at your contract rate (or the posted rate when you signed) and the interest at a second rate: the lender's current posted rate for a similar term, or that posted rate minus the discount you were originally given.
  • On a closed variable-rate mortgage the penalty is typically 3 months' interest.
  • Your mortgage contract sets exactly how your lender calculates the penalty.
  • A federally regulated lender, such as a bank, must tell you how it calculates the penalty and which factors it uses.
  • Breaking the contract can also cost administration, appraisal and reinvestment fees and a discharge fee, and you may have to repay any cash back you received.

Sources: FCAC, Prepayment penalties and Breaking your mortgage contract.

Method 1: three months’ interest

Three months’ interest is the interest your balance would cost over a quarter of a year at the rate the contract specifies:

Three months’ interest = balance × annual rate ÷ 12 × 3

FCAC’s own example uses a balance of $200,000 at 6%. The annual interest is $12,000, one month is $1,000, and three months’ interest is $3,000 (FCAC’s page shows $3,000).

Which rate goes into this formula is set by the contract, and lenders’ disclosures differ. CIBC, for example, calculates the three months’ interest on a fixed-rate mortgage at your rate plus any discount you received, and on a variable-rate mortgage at the CIBC Prime Rate. The big bank comparison lists each bank’s wording.

Method 2: the interest rate differential (IRD)

The IRD is the difference between the interest left on your term at your contract rate (or the posted rate when you signed) and the interest at a second rate: the lender's current posted rate for a similar term, or that posted rate minus the discount you were originally given. FCAC describes it this way: the lender calculates the interest left to pay on your current term at both rates, and the difference between the two amounts is the IRD.

A simplified version of that calculation:

IRD ≈ balance × (your rate − comparison rate) × months left ÷ 12

In FCAC’s example, 36 months are left in a 5-year term, and the lender’s current posted rate for a 36-month term is 4%. The rate gap is 2 percentage points, a year of that gap on the balance is $4,000, and over 3 years the IRD is $12,000 (FCAC’s page shows $12,000).

On a fixed-rate mortgage the penalty is the higher of the two methods, here $12,000. FCAC adds that you may also have to pay an administration fee.

Lenders’ actual calculations can be less simple. RBC and Scotiabank say they use the present value of the remaining interest and account for the balance declining with each payment; RBC says this reduces the amount calculated using the IRD compared with a straight multiplication. The contract sets the method; the lender’s calculator gives an estimate, and the lender gives the actual amount, which you can ask for in a written statement.

Why the original discount matters

The lender usually uses the IRD when your mortgage rate is higher than its current rate and you signed your current contract less than 5 years ago. When the comparison rate is the lender’s current posted rate minus the discount you were given when you signed, the comparison rate drops by the size of that discount, so the gap and the IRD grow.

Take FCAC’s example again, and suppose the borrower’s rate had been set 1.5 percentage points below the posted rate when they signed. A lender that subtracts that discount compares the 6% contract rate with 2.5% instead of 4%. The gap becomes 3.5 points, and the simplified IRD becomes $21,000, compared with $12,000 without the discount adjustment.

CIBC reaches the same kind of comparison from the other side: it adds your discount to your own rate and compares that with its current posted rate for the comparison mortgage named in your documents. Adding the discount to one rate or subtracting it from the other leaves the same gap.

Variable-rate mortgages

On a closed variable-rate mortgage the penalty is typically 3 months' interest. The rate used for the three months is set by the contract: for example, the interest rate applicable on the day of prepayment (BMO) or the CIBC Prime Rate (CIBC).

On a $300,000 balance at a variable rate of 5%, a year’s interest is $15,000, one month’s interest is $1,250, and three months’ interest is $3,750.

After five years: the Interest Act

  • The mortgage isn't payable until more than 5 years after the date of the mortgage.
  • Once 5 years have passed, you can pay what you owe plus 3 months' further interest, and no further interest can be charged.
  • It doesn't apply to a mortgage given by a joint stock company or other corporation.

Source: Interest Act, section 10. This matters for terms longer than 5 years. Scotiabank’s disclosure says that when your term is greater than 5 years and you prepay after the 5th year, the maximum cost is the three months’ interest amount, and BMO’s says the charge is three months’ interest after the 5th year of such a term.

Prepayment privileges and the penalty

FCAC suggests making full use of your prepayment privileges every year, because “Any future prepayment penalties will be based on a lower mortgage balance,” and making a lump-sum prepayment before you break. It also warns that some lenders restrict your ability to prepay if you’re close to the date you break your contract. Privileges vary from lender to lender; see prepayment privileges in Canada.

Getting the actual figure

A federally regulated lender, such as a bank, must tell you how it calculates the penalty and which factors it uses. FCAC says federally regulated financial institutions, like banks, have a prepayment penalty calculator on their website. Banks that are members of the Canadian Bankers Association have agreed to follow the federal Code of Conduct for Federally Regulated Financial Institutions: Mortgage prepayment information, which includes a toll-free number for prepayment questions, and you can ask for a written statement with the amount of the charge (FCAC, your rights with mortgage prepayment). The mortgage penalty calculator gives a rough estimate with your own numbers.

Alternatives to paying the penalty

FCAC lists ways to reduce or avoid a penalty: use your prepayment privileges, wait until the end of the term to prepay, port the mortgage to a new home if your lender allows it, and shop around at renewal. Lenders may also offer a blend-and-extend, which FCAC says avoids the prepayment penalty, although you may have to pay administrative fees.

If the reason for breaking is to borrow more against the home, a limit applies as well: Under the Bank Act, a bank's loan to buy, renovate or improve a home, or a refinance of such a loan, together with any mortgage ranking equal to or ahead of it, can't exceed 80% of the home's value.

The penalty on a rental property

The Canada Revenue Agency’s rental income guide covers penalties on a rental property’s mortgage: “You also prorate a penalty or bonus paid to a financial institution to pay off your mortgage loan before it is due.” It is deducted over the rest of the original term of the mortgage or loan, not all in one year.

Questions to ask before breaking

  • Is the mortgage open or closed, fixed or variable?
  • Which method applies, and which comparison rate and term does the lender use?
  • How much prepayment room is left this year, and can it be used before the break date?
  • Which other fees apply (administration, appraisal, reinvestment, discharge), and is any cash back repayable?
  • Would porting or a blend-and-extend avoid the penalty?

Sources

The figures and rules on this page come from these sources, last checked against them between September 29, 2026 and October 1, 2026. How we check facts.