What a mortgage prepayment penalty is — and when it applies
A prepayment penalty (also called a break fee, payout penalty or discharge charge) is what your lender charges when you pay off a closed mortgage before the end of its term. It exists because the lender funded your loan expecting a set stream of interest; ending it early disrupts that. It is set by your mortgage contract, not by the Bank of Canada or the government.
A penalty commonly applies when you:
- Sell your home and discharge the mortgage before the term matures.
- Refinance to pull out equity or change terms.
- Switch lenders for a better rate at renewal or mid-term.
- Pay down more than your prepayment privileges allow in a year.
Open mortgages (and some revolving or flex products) generally carry no or minimal penalties because you are allowed to pay them off at any time. Most Canadian homeowners, though, hold a closed mortgage — which is where the charge lives. With the 2026 renewal wave and rate uncertainty around the September 2, 2026 Bank of Canada decision, a lot of households are weighing whether to break, switch or simply ride out the term, so knowing the penalty math matters.
The two formulas lenders use — and why the greater one wins
For a closed mortgage, the penalty is almost always the greater of:
1. Three months' interest
Three months of interest on the outstanding balance at your contractual rate. Simple and usually modest.
Example: $400,000 balance at 5.00% → annual interest $20,000 → one month $1,667 → three months about $5,000.
2. Interest Rate Differential (IRD)
The IRD compares your contractual rate to the lender's current rate for a term comparable to your remaining term. The formula is:
IRD = (your rate − lender's current comparable rate) × outstanding balance × years remaining
When today's rates are below the rate you locked in, the gap is positive and the IRD can be large — this is what produces five-figure penalties on fixed mortgages.
| Method | On $400,000 at 5.00%, 3 years left | Result |
|---|---|---|
| Three months' interest | 5.00% × $400,000 × 3/12 | ~$5,000 |
| IRD (current 5-yr fixed ~3.94%) | (5.00% − 3.94%) × $400,000 × 3 | ~$12,720 |
| Charged (greater of) | Lender takes the higher amount | ~$12,720 |
Illustrative only. Your contractual rate, lender's posted/replacement rate, balance and remaining term all change the number. Use your own figures in the mortgage penalty calculator. As of August 23, 2026, advertised 5-year fixed rates were about 3.94% insured and 4.04% conventional, prime 4.45%, and the Bank of Canada overnight rate 2.25% — the wider the gap between your old rate and today's rate, the larger the IRD.
Why a fixed penalty usually dwarfs a variable penalty
The IRD is the reason. Variable-rate mortgages are normally charged three months' interest only (a few lenders may apply an IRD on variable — always check your contract). Because there is no rate-gap multiplication over the remaining term, the variable charge is typically a fraction of a fixed charge.
On that same $400,000 balance, a 3.35% variable rate produces three months' interest of only about $3,350, versus the five-figure IRD common on a higher fixed rate. That gap is the single biggest reason borrowers shopping a break should know which penalty regime their mortgage falls under. See the fixed vs variable Canada guide for the broader trade-off.
Your prepayment privileges: pay down without a penalty
Most closed mortgages let you pay extra each year without triggering the penalty, up to set limits:
- Lump-sum prepayment: typically 10% to 20% of the original principal per year (not the current balance).
- Double-up / increase: make an extra regular payment or raise your scheduled payment by a set percentage.
This matters for penalties because the IRD is calculated on the outstanding balance. Using your privileges to chip down the balance before you break lowers the base the charge is multiplied against — it can trim, though not eliminate, the penalty. Privileges are also how you pay toward your mortgage faster in normal times. Run the dollars through the mortgage payment calculator to see the balance and interest impact.
How to lower or avoid the penalty
- Port your mortgage. If you are moving, many lenders let you transfer (port) the existing mortgage — and its rate — to the new property, avoiding a break charge. A blend-and-extend can add new money at a blended rate.
- Time it near renewal. The penalty shrinks as your remaining term falls; waiting until close to maturity can dramatically cut the IRD.
- Use your privileges first. Pay down the allowed lump sum before discharging to lower the penalty base.
- Get it in writing. Ask your lender for a formal payout/discharge statement — that is the only authoritative number, and it can differ from a quick estimate.
- Weigh penalty vs savings. When refinancing or switching for a lower rate, the interest you save must exceed the break cost. Model both sides before committing.
None of this is personalized advice. Your contract — and your lender's specific IRD method (some use posted rates, some use discounted rates) — controls the final figure.
See what breaking or switching would actually cost
Headline rates are only half the story — the penalty can swallow the savings on a refinance or switch. RateShop lets you compare current purchase, renewal, switch and refinance options side by side, and our penalty calculator models the break charge on your own balance and rate so you can decide with real numbers instead of guesses.
Compare mortgage ratesIf you are refinancing or switching to a lower rate
The 2026 rate backdrop — the Bank of Canada holding at 2.25% with its next decision September 2, 2026, prime at 4.45%, and advertised 5-year fixed near 3.94% insured / 4.04% conventional — means the gap between an older higher fixed rate and today's rate can still produce a meaningful IRD. Two practical steps before you act:
- Get the written payout. Request your lender's discharge statement so you are working from the real penalty, not an estimate.
- Model penalty vs new rate. Compare the break cost against the interest saved on the new term using the penalty calculator and the payment calculator. Current pricing across terms and provinces is on the Canadian mortgage rates page, and renewal-specific options are on the mortgage renewal rates page.
Rate and penalty disclaimer
All rates, yields, prime and market figures on this page are general educational information gathered from public sources on or about August 23, 2026 and may be out of date, incomplete or superseded without notice. RateShop does not guarantee any rate, penalty amount, approval or product availability. Actual mortgage rates and prepayment penalties depend entirely on your individual mortgage contract, lender, outstanding balance, contractual rate, remaining term, insurance status, property and documentation. Prepayment penalties are set by your lender's contract (commonly the greater of three months' interest or the Interest Rate Differential) and can differ materially from any estimate, including those on this page or in any calculator. This page does not provide personalized mortgage, legal, tax or financial advice. Speak with a licensed mortgage professional and obtain a written payout statement from your lender about your own situation.
Frequently asked questions
What is a mortgage prepayment penalty in Canada?
A prepayment penalty (also called a break, discharge or prepayment charge) is a fee your lender charges when you pay off a closed mortgage before the end of its term. It applies if you sell and discharge the mortgage early, refinance, switch lenders, or pay more than your allowed prepayment privileges. Open mortgages generally have no or minimal penalties. The charge is set by your mortgage contract, not by the Bank of Canada.
How is a Canadian mortgage prepayment penalty calculated?
Most closed mortgages use the greater of two formulas: (1) three months' interest on the outstanding balance at your contractual rate, or (2) the Interest Rate Differential (IRD). The IRD is the difference between your contractual rate and the lender's current rate for a term comparable to your remaining term, multiplied by the outstanding balance and the time left. Lenders charge whichever number is higher. An illustrative example: on a $400,000 balance at 5.00% with 3 years left, three months' interest is about $5,000 while the IRD (using a current 5-year fixed near 3.94%) is about $12,720, so the charge would be the greater amount, roughly $12,720. Your own figure depends on your contract and balance.
Why is a fixed-rate mortgage penalty usually much higher than a variable-rate penalty?
Because the IRD is the dominant driver on fixed mortgages. When current market rates are below the rate you locked in, the IRD can be large. Variable-rate mortgages are usually charged three months' interest only (some lenders may use an IRD on variable — check your contract), which is typically far smaller. On the same $400,000 balance at a 3.35% variable rate, three months' interest is only about $3,350 versus the five-figure IRD common on a higher fixed rate.
How can I estimate my mortgage prepayment penalty?
Ask your lender for a written payout or discharge statement — that is the only authoritative number. You can also model it yourself with three months' interest and a simple IRD estimate, then compare with a dedicated calculator. RateShop's mortgage penalty calculator lets you test the charge before you commit to a break, refinance or switch. The estimate is educational and may differ from your lender's final figure.
Can I reduce or avoid the penalty using my prepayment privileges?
Prepayment privileges let you pay down a portion of your mortgage each year — commonly a lump sum of 10% to 20% of the original principal plus doubled-up regular payments — without penalty. Using privileges before you break lowers the outstanding balance the IRD is calculated on, which can trim the charge. Privileges do not eliminate the penalty on the amount you still owe, but they reduce its base. Porting the mortgage to a new property, blending-and-extending, or timing the break close to renewal can also reduce or avoid a charge.
Does the Bank of Canada rate decision affect my prepayment penalty?
Not directly. The penalty is a contract term, not a Bank of Canada setting. But the Bank's policy rate influences the market rates your lender uses in the IRD comparison. As of August 23, 2026 the Bank of Canada held its overnight rate at 2.25% (next decision September 2, 2026) and prime was 4.45%; current advertised 5-year fixed rates sat near 3.94% insured and 4.04% conventional. A higher or lower rate environment changes the gap between your old rate and today's rate, which is exactly what drives the IRD portion of the penalty.
Sources used
- Bank of Canada: Policy interest rate (2.25% held July 15, 2026; 2026 announcement schedule, next decision September 2, 2026)
- WOWA.ca: Canada mortgage rates (snapshot August 23, 2026 — lowest 5-year fixed 3.94% insured / 4.04% conventional, 5-year variable 3.35% insured / 3.40% conventional, prime 4.45%)
- Financial Consumer Agency of Canada (FCAC): Mortgage prepayment — privileges and prepayment charge guidance (standard IRD vs three-months'-interest methodology; canada.ca was unreachable this run, methodology cited from established FCAC consumer guidance and standard Canadian mortgage contracts)