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Breaking Your Mortgage Without Breaking The Bank - How Mortgage Penalties Are Calculated

July 28, 2022 | Posted by: Justin Emilio


While low-interest rates may seem to save you the most money, looking deeper into your mortgage product could save you thousands.
While you may intend to keep your mortgage for the duration of the term, nearly 70% of Canadians break their term early. This is why one of the most important features of your mortgage product to consider is the mortgage penalty calculation.

The two most common mortgage penalty calculations are known as Interest Rate Differential (IRD) and 3 Months Interest.

3 months Interest – This calculation is most commonly used for variable rate mortgage penalties. The following formula is used: [(mortgage rate/months in a year) x mortgage balance) x 3 = penalty.

Example: Let’s say that you wanted to pay out a $300,000 mortgage with a variable rate of 3%. The approximate penalty would be $2,250.

     ((.03/12) x $300,000) x 3 = $2,250

Interest Rate Differential (IRD) has two calculations that they use. The first is Standard IRD and the second is Discounted Rate IRD.

Standard IRD – This calculation is often higher than 3 months of interest. Many non-bank mortgage lending institutions use this method.

The IRD is based on:
  • The amount you are pre-paying;
  • Your original mortgage interest rate and
  • The lenders’ current interest rate.
The following formula is typically used:

(your existing mortgage rate – lender’s current rate that most closely matches your remaining term) x mortgage balance x remaining term)

Example: let’s say your current mortgage rate is 3.5% with 3 years left on your term. You want to pay out $300,000. Your lenders’ rate for their 3-year term is 3.0%. The mortgage penalty would be $4,500.

     (3.5% – 3.0%)/12 x $300,000 x 36 = $4500

Most closed fixed-rate mortgages have a prepayment penalty that is the higher of 3-months interest or the IRD. In the example above since the standard IRD penalty of $4,500 is greater than three months interest ($2,250) you’d pay $4,500.

Discounted Rate IRD Penalty Calculation: This calculation is most commonly used by banks and credit unions. Instead of using the current rate that most closely matches your remaining term like in the standard IRD calculation, the lender uses the POSTED rate that most closely matches your remaining term MINUS the original discount you got off the posted rate for your original term. This is an unfair comparison because short-term fixed-rate mortgages are often discounted much less than long-term mortgages

The following formula is typically used:

[your existing mortgage rate – (lender’s posted rate that most closely matches your remaining term – original discount you received) ] x mortgage balance x remaining term

Example: let’s say your current mortgage rate is 3.5% with 3 years left on your term. You want to pay out $300,000. When you took out your mortgage the 5-year posted rate was 5.1%, and the lenders posted rate that most closely matches your remaining term is 3.94%. The mortgage penalty would be $21,060.

[3.5%-(3.94-1.6%)]/12 x $300,000 x 36 = $21,060

Your IRD penalty has just gone up from $4,500 to $21,060 because the lender uses the discounted rate penalty calculation rather than the standard penalty calculation.

Each person’s financial situation and future plans are unique which is why it is important to consider mortgage products based on your needs rather than interest rate alone.

We strongly recommend that you speak with your mortgage professional to fully understand your mortgage options and all the product features.

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