If you're considering paying off your mortgage early, you may be surprised to learn that you could face a prepayment penalty. In Canada, prepayment penalties are a common practice among lenders, and they can significantly impact your finances. In this article, we'll explore what prepayment penalties are, how they work, and which provinces in Canada allow them.
What Are Prepayment Penalties?
A prepayment penalty is a fee that a lender charges when a borrower pays off their mortgage before the end of the term. This fee is meant to compensate the lender for the interest they would have earned if the borrower had continued to make regular mortgage payments until the end of the term.
Prepayment penalties are typically calculated as a percentage of the outstanding mortgage balance or as a certain number of months' worth of interest. The exact amount of the penalty will vary depending on the lender and the terms of the mortgage.
How Do Prepayment Penalties Work?
Prepayment penalties are usually triggered when a borrower pays off their mortgage in full or makes a lump sum payment that exceeds the allowed prepayment amount. This amount is usually a percentage of the original mortgage amount, such as 20% or 25%.
For example, if you have a mortgage of $300,000 and your prepayment amount is 20%, you can make a lump sum payment of up to $60,000 without incurring a penalty. However, if you make a payment of $70,000, you will be charged a prepayment penalty on the extra $10,000.
Why Do Lenders Charge Prepayment Penalties?
Lenders charge prepayment penalties to protect themselves from potential losses. When a borrower pays off their mortgage early, the lender loses out on the interest they would have earned if the borrower had continued to make regular payments until the end of the term.
Prepayment penalties also discourage borrowers from refinancing their mortgage with a different lender, as this would result in the original lender losing out on the interest they would have earned.
Which Provinces Allow Prepayment Penalties?
In Canada, prepayment penalties are allowed in all provinces and territories except for Quebec. However, even in provinces where prepayment penalties are allowed, there are certain restrictions and regulations in place.
Provinces That Allow Prepayment Penalties
The following provinces and territories allow prepayment penalties:
Provinces That Don't Allow Prepayment Penalties
The only province in Canada that does not allow prepayment penalties is Quebec. This is due to the Consumer Protection Act, which prohibits lenders from charging penalties for early mortgage repayment.
Restrictions and Regulations
Even in provinces where prepayment penalties are allowed, there are certain restrictions and regulations in place to protect borrowers. For example, in Ontario, lenders are required to provide borrowers with a prepayment penalty disclosure statement that outlines the penalty amount and how it is calculated.
In addition, some provinces have limits on the amount of the prepayment penalty. For example, in British Columbia, the penalty cannot exceed three months' worth of interest, while in Alberta, the penalty cannot exceed the lesser of three months' worth of interest or the interest rate differential (IRD).
How to Avoid Prepayment Penalties
If you want to avoid prepayment penalties, there are a few strategies you can use:
Prepayment penalties are a common practice among lenders in Canada, and they can significantly impact your finances if you're not aware of them. It's important to understand how prepayment penalties work and which Provinces in Canada allow them. By negotiating with your lender and choosing a mortgage with a lower prepayment penalty, you can avoid these fees and save money in the long run.
By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929