Mortgage penalty in Canada: 3 months' interest vs IRD, with a calculator
When rates fall, breaking your mortgage for a lower rate sounds like free money. Sometimes it is. Often the penalty eats the savings, and the difference comes down to one line in your contract: how your lender picks the rate it compares yours against. Here is how the two penalty methods work, a calculator that runs both, and the arithmetic for deciding whether breaking pays.
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Mortgage penalty and break-even calculator
Estimate the penalty, then the savings
3 months' interest = balance × contract rate ÷ 4. The IRD uses the simplified method FCAC shows: balance × (your rate minus the comparison rate) × months left ÷ 12. FCAC's guidance to lenders says a simplified calculation gives an estimate that is higher than the actual charge when the lender applies the time value of money, so treat this as a ceiling to check against your lender's own figure. Interest saved compares the next months of interest at each rate on the same balance and amortization, with interest compounded semi-annually as Canadian fixed mortgages usually state it.
When a prepayment penalty applies
FCAC says a lender may charge a prepayment penalty if you:
- pay more than your allowed extra amount in a year,
- break your mortgage contract,
- transfer your mortgage to another lender before the term ends, or
- pay back the whole mortgage before the term ends, including when you sell.
Your lender may call it a prepayment charge or a breakage cost. An open mortgage lets you prepay without a penalty. Most people have a closed mortgage, which is where the rules below kick in. If you only want to pay extra, your yearly allowance may be enough; see our guide to mortgage prepayment privileges.
The two methods: 3 months' interest and the IRD
FCAC says the penalty will usually be the higher of:
- 3 months' interest on what you still owe, or
- the interest rate differential (IRD).
FCAC adds that lenders usually use the IRD when your mortgage rate is higher than the current rate and you signed your current contract less than 5 years ago. That is exactly the situation after rates fall, which is why penalties surprise so many people at the moment they most want to move.
Many variable-rate contracts charge 3 months' interest only, but this is a contract term, not a law. The calculator's Variable setting uses 3 months' interest only; check the information box at the start of your agreement to see which applies to you.
How the IRD is calculated, and why the comparison rate matters
FCAC explains that a lender typically takes two rates, works out the interest left to pay on your current term at each, and charges the difference. The first rate can be:
- the posted rate when you signed, or
- your current or discounted rate as your contract describes it.
The second rate can be:
- the current posted rate for a term close to what you have left, or
- that current posted rate minus the discount you were originally given.
Posted rates are the rates a lender advertises. If you signed below the posted rate, you got a discounted rate. When the lender subtracts your old discount from today's posted rate, the comparison rate drops, the gap widens, and the IRD grows. Same balance, same months, very different penalty. Your lender must tell you which rates and which term it used: under the federal code on mortgage prepayment information, a federally regulated lender has to give you the outstanding amount, your annual rate, the comparison rate and the remaining term used in the calculation.
Worked example: one mortgage, three comparison rates
Priya owes $350,000 at a fixed 5.29% with 30 months left. She signed at a discount of 1.20 points below the posted rate. Today her lender posts 5.04% for the closest term. These figures are illustrative.
- 3 months' interest: $350,000 × 5.29% ÷ 4 = $4,628.75.
| Comparison rate used | Rate gap | IRD (balance × gap × 30 ÷ 12) | Penalty (higher of the two) |
|---|---|---|---|
| Current posted rate, 5.04% | 0.25 points | $2,187.50 | $4,628.75 (3 months' interest wins) |
| A 3.99% rate for the term | 1.30 points | $11,375.00 | $11,375.00 |
| Posted minus her 1.20 discount, 3.84% | 1.45 points | $12,687.50 | $12,687.50 |
The spread between the first and last rows is $8,058.75, and nothing about Priya's mortgage changed except the method. That is why the first question to ask is not "what is my penalty" but "which rates did you compare, and why".
FCAC's own example lands the same way: $200,000 at 6%, 36 months left, a 4% comparison rate. 3 months' interest is $200,000 × 6% ÷ 4 = $3,000. The IRD is $200,000 × 2% × 36 ÷ 12 = $12,000. The penalty is the higher amount, $12,000, plus any administration fee.
Is breaking worth it after rates fell?
Breaking pays only when the interest you save over the rest of the term beats the penalty plus every other cost. FCAC lists the costs to check: the penalty, administration fees, appraisal fees, reinvestment fees, a discharge fee, and repaying any cash back you received.
Run Priya's numbers with a new rate of 3.99%, her 22 years of remaining amortization and $1,000 of other fees:
- Interest over the next 30 months at 5.29%: about $44,385. At 3.99%: about $33,393. Saved: about $10,993.
- With the posted-minus-discount IRD of $12,687.50, the result is $10,993 minus $12,687.50 minus $1,000 = about $2,695 worse off.
- If her contract only charged 3 months' interest ($4,628.75), the same move would leave her about $5,364 ahead.
Two other things FCAC flags: you may end up paying more because of fees and the penalty, and you may no longer qualify for a mortgage under current conditions. If you are switching lenders at renewal rather than mid-term, OSFI has not required a straight switch to pass the stress test again since November 21, 2024; see our stress test guide. Mid-term breaks are a new mortgage, so ask what applies.
The 5-year rule in the Interest Act
Section 10 of the federal Interest Act covers mortgages whose money is not payable until more than five years after the mortgage date. After five years have passed, the borrower can pay off what is owed plus three months' further interest, and no further interest can be charged. It does not apply to mortgages given by a corporation. If you are in year six of a longer term, ask your lender how this applies to you.
Ways to reduce or avoid the penalty
FCAC suggests:
- Use your prepayment privileges first. A lump sum within your allowance lowers the balance the penalty is based on. Some lenders restrict prepaying close to the date you break, so ask.
- Wait for the end of the term if the penalty is large. At maturity you can prepay without a penalty. Our renewal guide has the countdown.
- Port the mortgage if you are moving. See porting a mortgage.
- Ask about blend and extend. FCAC says lenders may let you extend early without a prepayment penalty, though administrative fees may apply. Our blend and extend guide runs FCAC's blended rate method.
Options people compare when rates fall
| Option | Penalty | Watch for |
|---|---|---|
| Break and refinance | Higher of 3 months' interest or IRD | Fees, cash back clawback, qualifying again |
| Blend and extend | None, per FCAC | Admin fees; ask how the blended rate is set |
| Prepay within privileges, then wait | None within your allowance | Allowance usually does not carry forward |
| Wait for renewal | None at maturity | Paying the higher rate until then |
These are options to understand, not recommendations. More calculators are on the tools page.
How to estimate your mortgage prepayment penalty
- Find the prepayment section in the information box at the start of your mortgage agreement.
- Note your balance, contract rate and the months left in your term.
- Ask your lender which comparison rate and term it uses, and whether it subtracts your original discount.
- Work out 3 months' interest: balance times contract rate divided by 4.
- Work out the IRD: balance times the rate gap times months left divided by 12, and take the higher of the two for a fixed mortgage.
- Add discharge, appraisal and other fees, then compare against the interest a new rate would save over the rest of the term.
Questions people ask
How is a mortgage penalty calculated in Canada?
For most closed fixed mortgages, the penalty is the higher of 3 months' interest on what you owe or the interest rate differential. FCAC says lenders usually use the IRD when your rate is above the current rate and you signed less than 5 years ago.
What is the IRD on a mortgage?
The interest rate differential is the difference between the interest left on your term at your rate and at a comparison rate. In simple form: balance times the rate gap times the months left divided by 12.
Why is my IRD so high?
Usually because of the comparison rate. FCAC says a lender may compare against the current posted rate minus the discount you were first given, which makes the gap larger and the IRD bigger.
Is the penalty on a variable mortgage 3 months' interest?
Many variable-rate contracts charge 3 months' interest only, but it depends on your agreement. Check the prepayment section of your information box.
Can I avoid a mortgage penalty?
FCAC suggests using your prepayment privileges, waiting until the end of your term, porting the mortgage if you move, and asking about blend and extend, which does not carry a prepayment penalty though fees may apply.
Is it worth breaking my mortgage to get a lower rate?
Only if the interest saved over the rest of the term is larger than the penalty plus fees such as discharge, appraisal and any cash back you must repay. Run both numbers before deciding.
Does the penalty change after 5 years?
Under section 10 of the Interest Act, for a mortgage not payable until more than five years after its date, after five years you can pay off the balance with three months' further interest. It does not apply to mortgages given by corporations.
What must my lender tell me about the penalty?
A federally regulated lender must explain how it calculates the penalty and, under the federal code, give you the balance, your rate, the comparison rate and the remaining term it used.
Looni is being built to read your statements, flag fees with proof, and keep a countdown to your renewal date so you can compare options early. Read-only, no advice.
Sources
Financial Consumer Agency of Canada, Mortgage fees: Prepayment penalties (when penalties apply, higher of 3 months' interest or IRD, the IRD rates lenders can use, the $200,000 example, tips), Breaking your mortgage contract (fees to check, blend and extend, pros and cons), CG-9 Mortgage prepayment penalty disclosure (simplified estimate higher than the actual charge) and the Code of Conduct on mortgage prepayment information; Justice Laws, Interest Act, section 10. Priya's rates are illustrative; the arithmetic is ours.