Variable rate: the simple one
Break a variable mortgage and the penalty is almost always three months of interest on the outstanding balance. On a five hundred thousand dollar mortgage, that is a few thousand dollars: real money, but rarely a reason to stay trapped in the wrong mortgage.
Fixed rate: the differential
Fixed penalties are the greater of three months interest or the interest rate differential, which compensates the lender for the interest it loses. The formula compares your rate to the rate the lender can lend at today for your remaining term. When rates have fallen since you signed, the differential grows, sometimes dramatically.
- Bigger remaining term means bigger potential differential
- Falling rates make fixed penalties worse
- Your discount off posted rate inflates the comparison
Why bank penalties dwarf monoline penalties
Big banks calculate the differential against their posted rates, which sit far above the discounted rates anyone actually pays. Monoline lenders, the ones brokers often place mortgages with, typically use their actual rates. The same mortgage, same rate drop, same remaining term: the bank penalty can be three or four times larger. This is one of the least-known facts in Canadian mortgages.
Shrinking the penalty legally
Use your annual prepayment privilege, often ten to twenty percent, right before the payout, since the penalty is calculated on the reduced balance. Time the break near maturity or near a rate rise, which shrinks the differential. Port instead of breaking when moving. Each lever is worth real money and costs nothing but planning.
The number that matters
Online estimates are rough. Ask your lender for a written payout statement with the exact penalty, valid for a set window. That figure, plus discharge and legal costs, is the true price of breaking, and it is the only number worth making a decision on.
Frequently asked questions
- Can I avoid the penalty entirely?
- Breaking at maturity is free. Porting to a new property avoids it. Some lenders waive it if you take a new larger mortgage with them. Otherwise it is the price of exiting early.
- Is the penalty tax deductible?
- On income-producing property, generally yes. On your home, no. Your accountant can confirm for your situation.
- Why was my penalty so much bigger than my friend's?
- Different lenders, different formulas, different remaining terms, different rate environments. The lender choice at signing is what determined the penalty years later.