Understanding Prepayment Penalty: Avoid Extra Mortgage Costs

Pre-payment penalties, also known as a mortgage prepayment penalty or mortgage penalty, are a big business for Canadian financial institutions. A prepayment penalty is a fee that is imposed by mortgage lenders when a borrower pays off their mortgage loan earlier than the agreed term, either by paying off mortgage early, incurring an early mortgage payoff penalty, or facing a penalty to pay off mortgage early. Because the lender loses interest payments as a result of early payment, the borrower will have to pay a prepayment charge to compensate the lender for this loss.

Prepayment penalties are not a one size fits all fee. Depending on the mortgage lender and type of mortgage the borrower has, the penalty can be more or less expensive. The size of the mortgage balance also matters. Understanding the meaning of prepayment is important.

Open mortgages usually offer more flexibility because there is no penalty involved. Usually in exchange for a higher mortgage rate or interest rate, borrowers have the peace of mind of knowing that they can pay off the mortgage at any time without being on the hook for additional fees like a prepayment penalty. Open mortgages include lines of credit products that are attached to secured home equity lines of credit. They also allow for mortgage lump sum payments without penalty.

Closed mortgages, on the other hand, do come with penalties but the type of mortgage will determine the amount of penalty. Variable-rate mortgages or adjustable rate mortgages usually only incur a three month interest penalty whereas fixed-rate mortgages come with an IRD penalty or three month interest penalty, whichever one is higher. You can use a mortgage penalty calculator to estimate the prepayment mortgage penalty.

As you can see, it's very important to understand your mortgage term, amortization period and mortgage contract. Even when calculating the IRD, which stands for Interest Rate Differential, each mortgage lender may use a different prime rate to plug into the equation which can change the total cost. Big banks tend to have the most costly prepayment penalties, which means they may not always be the best option for fixed rate mortgage loans.

Other factors that can impact mortgage prepayment penalties include refinancing, whether you have mortgage prepayment privileges, if you port your mortgage to a new property, and fees involved in mortgage renewal. Lump-sum payments may also be subject to annual prepayment limits. Be sure to understand any prepayment charges before breaking your mortgage contract. A careful IRD calculation and understanding prepayment charge calculations and any prepayment limits is important. Mortgage assumption, where a buyer takes over the seller's existing mortgage, can help avoid early mortgage payoff penalties in some cases.


If you're wondering about prepayment penalties and the best mortgage for you, please feel free to contact. our office today at 647-773-4849. 

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