Explained
How Canadian mortgage penalties are calculated
Two methods, one of which costs several times the other on identical numbers — and your contract decided which one applies before you signed it.
Written by Hermann Gael Nang-Song · Last reviewed August 25, 2026Founder of LoonieLodge Inc., and author of the Canadian mortgage engine this site runs on.
Every closed mortgage has a floor, and most have a second calculation
Breaking a closed mortgage early triggers a prepayment charge, and in Canada it is almost always the greater of two figures. The first is three months' interest on the balance being paid out, which is simple arithmetic and is what a closed variable-rate mortgage is usually charged. The second is an interest-rate differential — the IRD — and it exists to make the lender whole for the interest they will not now receive over the rest of your term.
On a variable-rate mortgage the IRD normally does not apply at all, because there is no fixed rate to measure a differential against. On a closed fixed-rate mortgage it usually does, and it is the figure that makes the news.
The IRD is one idea with two very different implementations
The differential is your contract rate minus a comparison rate, multiplied by the balance and by the time left. The whole argument is over which comparison rate. Monolines and most credit unions use the rate they are currently *offering* for a term closest to the time you have left; if that rate is at or above your contract rate there is no differential and you pay the three-month floor.
The big banks use their *posted* rate for the same remaining term, and then subtract the discount you were originally given — the gap between the posted rate on the day you signed and the rate you actually got. Posted rates sit well above anything a customer pays, so subtracting your discount from one produces a comparison rate far below your contract rate, and a differential where the other method finds none. The bigger your original discount, the bigger the penalty.
Two things follow that are worth knowing before you sign anything. The method is a term of your contract and is not negotiable at the moment of breaking. And a mortgage given by a natural person is subject to section 10 of the Interest Act, which caps the charge at three months' interest once the mortgage is more than five years old — a protection that surprises people who have held the same mortgage a long time.
Worked example
The same mortgage, broken under each method
A $400,000.00 balance at 2.89%, with 30 months left on the term. The lender's current rate for a term that length is 4.29%; the posted rate when the mortgage was written was 5.34%, so the original discount was 2.45 points. Nothing changes between the rows except which comparison rate the contract names.
| Method | Charge |
|---|---|
| Three months' interest | $2,890.00 |
| IRD — against the offered rate | $2,890.00 |
| IRD — against the posted rate | $10,500.00 |
The posted-rate method costs $7,610.00 more on identical numbers — 3.63 times the charge. That is not a difference in the mortgage; it is a difference in one clause of the contract, and it is knowable before you sign. Estimates from the assumptions stated above: your lender computes the real figure from your own contract with their own rounding.
Ask any lender quoting you a fixed rate which comparison rate their prepayment charge uses, and get the answer in writing. It is the single most expensive sentence in a mortgage contract that nobody reads.
Run it on your own numbers
The same arithmetic, on the figures from your own mortgage. No account, and nothing you type is stored.
Sources
Primary sources, named. Where a figure comes from a statute we cite the section, because the section is what your lender's lawyer will read.
- Financial Consumer Agency of Canada — Paying off your mortgage faster
- Bank Act, s. 449 — prepayment charge disclosure
- Interest Act, s. 10 — the five-year rule on mortgages given by a natural person
Written and maintained by the author of the mortgage engine this site runs on, and reviewed against the sources named below. LOONIELODGE does not arrange mortgages, takes no commission from lenders, and nothing here is ranked or recommended because somebody paid for it.
Educational and informational only — not licensed mortgage, financial, legal or tax advice. Every lender's contract governs its own mortgage, and the figures here are estimates from stated assumptions rather than quotes. Confirm anything you intend to act on with your lender and a licensed professional.
Last reviewed August 25, 2026
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