Everything You Need to Know About Mortgage Pre-Payment Penalties for Canadians

When it comes to managing your mortgage, the term “pre-payment penalty” can sometimes catch homeowners off guard. Let’s talk about what pre-payment penalties are, why they exist, and how you can navigate them effectively as you pay off your home loan.

What are mortgage pre-payment penalties? Why do they exist?

Mortgage pre-payment penalties are fees that lenders may charge if you pay off your mortgage early or make extra payments beyond the allowed limit specified in your contract. While it might seem counterintuitive to penalize someone for paying off debt early, these fees exist to compensate lenders for the interest they would lose on the remaining term of the loan.

Lenders rely on the interest from your mortgage payments as a significant source of revenue. When you pay your mortgage off ahead of time, lenders miss out on that expected interest income, so to combat this, pre-payment penalties are included in mortgage agreements.

How are pre-payment penalties calculated?

In Canada, pre-payment penalties are typically calculated using one of two methods, three-month interest or interest rate differential. Which method your lender will use depends on whether you have a fixed interest rate or variable interest rate mortgage, among other factors.

Three-Month Interest Penalty

This is the simpler method, where the lender charges the equivalent of three months’ interest on the remaining balance of your mortgage.

Interest Rate Differential (IRD)

The IRD calculation can be more complex and often results in higher penalties for homeowners. The typical way it’s calculated is by taking the current balance left on your mortgage and calculating the difference in overall interest cost using your original mortgage rate versus the current rate for a similar term (based on the time remaining) minus the discount you received off the posted rates at the start of the mortgage.  Fairly complex; thankfully however, lenders are mandated to provide online calculators that borrowers can use to estimate this cost, rather than having to run elaborate calculations themselves. 

When do pre-payment penalties apply?

You may incur pre-payment penalties in a few situations during the course of your mortgage:

• Selling your home before your mortgage term ends, but you don’t port your mortgage (take your mortgage from your old home to your new home).
• Refinancing your mortgage early for a better rate
• Paying a lump sum higher than allowed in your mortgage agreement.  These lump sums vary amongst lenders between 10%-20% of the original principal amount.. 

How can I minimize or avoid mortgage pre-payment penalties?

There are a few strategies you can use to minimize or avoid paying pre-payment penalties, even if you’re selling your home or paying off your mortgage early.

Understand the terms of your mortgage

Read through your mortgage agreement before making any big changes, to understand your specific pre-payment options and penalties. As indicated previously, most lenders allow extra payments of up to 10-20% of the original mortgage amount annually without penalty, so it’s worth knowing what that limit is and strategically paying off your mortgage early.  Equally important is to confirm if there are any specific terms or restrictions.  For example, while some lenders allow you to make these pre-payments on any payment date, others may only allow it on the anniversary date of the mortgage; therefore, it’s really important to pin this down with your mortgage lender.   

Choose a flexible mortgage by working with a mortgage broker

If pre-payment terms are important to you, working with a broker like Auxilium will help you find the best mortgage to give you flexibility to pay off your loan early.  Ensure that you communicate to your broker how important this is, and what kind of options you would like when it comes to this. 

Port your mortgage when selling your home

When selling your home, porting (aka “transferring”) your mortgage to your new home can help you avoid penalties; however, it’s important that you confirm with your existing lender what conditions and terms they have when it comes to porting.   There is no “one size fits all”; the rules around this can vary greatly from lender to lender.   

Let’s minimize your pre-payment penalties, together

At Auxilium Mortgage, we pride ourselves on finding the best mortgage options for our clients. Whether you’ve got less-than-stellar credit or need flexible terms to be able to pay off your mortgage early, there’s a great mortgage option out there for you and we can find it.

Contact us today for a no-obligations consultation — no credit check required!

Sharing is caring!