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The Penalty for Breaking a Mortgage Contract Early

  • Jan 30
  • 7 min read

Owning a home is a major financial commitment. In some situations, homeowners may need to end their mortgage contract before the term expires. While breaking a mortgage can make sense in certain circumstances, it often comes with prepayment penalties and additional fees, especially for closed mortgages, which can amount to thousands of dollars.


In addition to the prepayment penalty, borrowers may face other costs such as mortgage discharge fees, appraisal fees, administrative or processing fees, and legal or notary fees, depending on the lender, province, and transaction.


Homeowners may break their mortgage for various reasons, including changes in interest rates, personal or family circumstances, or the need to move or refinance. Before making this decision, it is important to carefully weigh the potential benefits against the full cost. In some cases, alternatives such as renegotiating the mortgage or using lender options like blend-and-extend may help reduce costs, depending on the contract and lender.



Key Takeaways

● Breaking a mortgage contract early in Canada can result in significant prepayment penalties and additional fees.

● Common reasons include falling interest rates, life changes, relocation, or refinancing needs.

● Alternatives such as renegotiation, porting, or blend-and-extend may be available, depending on the lender and mortgage agreement.

● It is essential to compare total costs with potential savings before deciding to break a mortgage.


Understanding Mortgage Contract Termination


Homeowners in Canada may need to consider ending a mortgage early for various reasons. Understanding how different mortgage contracts work and how penalties are calculated is essential to making an informed decision.


Types of Mortgage Contracts: Open vs. Closed


● Open mortgages generally allow borrowers to repay the full balance at any time without a prepayment penalty, but they usually have higher interest rates.

● Closed mortgages restrict early repayment and typically involve a prepayment penalty if the mortgage is ended before the term expires.


Common Reasons for Early Termination


Homeowners may consider breaking a mortgage due to:

● lower market interest rates,

● changes in income or employment,

● family or life changes,

● selling or moving to a new home, or

● refinancing or accessing equity.



Initial Considerations Before Breaking


Before breaking a mortgage, borrowers should:

● review their mortgage agreement,

● request a written penalty estimate from their lender, and

● consider current interest rates, the remaining term, and whether potential savings outweigh the costs.


Understanding these factors can help homeowners make decisions that support their long-term financial health.


Breaking a Mortgage Contract: Key Factors to Consider


Breaking a mortgage early involves several key factors, including:

● current market interest rates,

● the interest rate in the existing contract,

● the remaining mortgage term, and

● how the prepayment penalty is calculated.


It is important to assess whether the long-term benefits justify the immediate costs.


Mortgage Type and Typical Penalty Calculation

Mortgage Type

Typical Penalty Calculation*

Closed Fixed-Rate

Usually the higher of three months’ interest or the Interest Rate Differential (IRD)

Closed Variable-Rate

Typically three months’ interest

*Actual calculations vary by lender and mortgage agreement.


Breaking a mortgage may also involve additional fees, such as administrative or reinvestment fees, appraisal fees, mortgage discharge fees, and repayment of cash-back incentives. These costs vary by lender and can significantly affect the total financial impact.



Calculating Prepayment Penalties


Breaking a mortgage contract early in Canada can result in substantial costs. For closed mortgages, lenders typically calculate the prepayment penalty using one of two methods and apply whichever amount is higher, as outlined in the mortgage agreement.


How Prepayment Penalties Are Calculated


● Three months’ interest on the outstanding mortgage balance; or

● Interest Rate Differential (IRD), which compensates the lender for interest income lost when the mortgage is ended early.


The exact calculation depends on the mortgage type, remaining term, and the lender’s specific methodology.


Interest Rate Differential (IRD)


The IRD compares:

● the interest rate in the mortgage contract, and

● the lender’s current rate for a term similar to the remaining length of the mortgage.


For fixed-rate mortgages, the prepayment penalty is often the greater of IRD or three months’ interest. Because IRD calculations vary by lender and may involve posted rates, penalties for fixed-rate mortgages can be significantly higher than those for variable-rate mortgages.


Variable-Rate Mortgages


For most closed variable-rate mortgages in Canada, the prepayment penalty is typically three months’ interest. IRD calculations generally do not apply, though borrowers should always confirm the terms in their specific mortgage contract.


Additional Fees to Consider


In addition to the prepayment penalty, breaking a mortgage early may involve:

● mortgage discharge fees,

● administrative or processing fees,

● appraisal fees (if refinancing), and

● repayment of any cash-back incentives received at the start of the mortgage.


These fees vary by lender and province and can increase the overall cost of ending a mortgage early.


Making an Informed Decision


Before breaking a mortgage contract, borrowers should:

● carefully review their mortgage agreement,

● request a written breakdown of penalties and fees, and

● compare the total cost of breaking the mortgage with any potential interest savings.


Understanding how penalties and related fees work can help ensure the decision aligns with financial goals and long-term plans.



Fixed-Rate Mortgage Break Penalties


Breaking a fixed-rate mortgage early in Canada can result in significant costs. For most closed fixed-rate mortgages, the prepayment penalty is usually calculated as the greater of three months’ interest or the IRD. The IRD can be higher when interest rates have fallen since the mortgage was taken out.


Lenders apply these penalties to compensate for potential interest income lost when a mortgage ends early. Depending on the lender and contract, alternatives such as renegotiation, porting, or blending options may be available.


Additional costs such as legal fees, registration costs, appraisal fees, and mortgage discharge fees should also be considered when evaluating whether breaking a mortgage makes financial sense.


Ways to Reduce the Impact of a Mortgage Break


● Using permitted prepayment privileges to reduce the outstanding balance

● Choosing shorter mortgage terms to reduce exposure to potential penalties

● Reviewing penalty calculations and discussing them with the lender before signing a mortgage agreement


Understanding how the IRD works and being aware of available strategies can help borrowers manage fixed-rate mortgage penalties more effectively.


Variable-Rate Mortgage Termination Costs


Breaking a closed variable-rate mortgage early in Canada usually results in lower penalties than breaking a fixed-rate mortgage, because IRD calculations typically do not apply.


For most closed variable-rate mortgages, the prepayment penalty is three months’ interest on the outstanding balance. The exact amount depends on the interest rate, mortgage balance, and contract terms.


Understanding Variable-Rate Calculations


Variable-rate mortgage interest rates in Canada are commonly tied to the lender’s prime rate. When the prime rate changes, the mortgage interest rate usually changes as well, depending on the contract.


Because the prepayment penalty is based on the current interest rate, changes in the prime rate can affect the dollar amount of the termination cost.


Impact of Market Conditions


Market conditions can influence the cost of ending a closed variable-rate mortgage early because the penalty is calculated as three months’ interest using the current rate. Higher rates generally result in higher penalties, while lower rates generally result in lower penalties.


Some lenders may offer alternatives such as blend-and-extend, which blends the existing rate with a new rate and extends the mortgage term. Availability and conditions vary by lender.


The Blend-and-Extend Option


A blend-and-extend option, offered by some Canadian lenders, may allow borrowers to adjust their interest rate without fully breaking the mortgage. The blended rate is a weighted average of the existing rate and the lender’s current rate.


Some lenders offer:

● Blend-and-extend, which blends the rate and extends the term

● Blend-to-term, which blends the rate for the remaining term only


These options may reduce or avoid a full prepayment penalty, but they are not guaranteed and depend on lender policies.


Pros of Blended Mortgages

● May reduce or avoid a full break penalty

● May lower the interest rate compared to the existing contract

● Avoids switching lenders in some cases


Cons of Blended Mortgages

● Less flexible than refinancing

● May not offer the lowest available market rate

● Cost savings depend on contract terms


Administrative and Legal Fees


Breaking a mortgage early may involve additional fees, including:

● mortgage discharge fees,

● administrative or processing fees, and

● legal or notary fees if new mortgage documents must be prepared and registered.


These costs vary by lender, province, and transaction complexity and should be considered alongside any prepayment penalty.



Switching Lenders: Additional Considerations


Switching lenders requires careful comparison of interest rates, terms, fees, and qualification requirements. Some lenders may offer incentives, such as cash-back, but these often have conditions.


Borrowers may need to re-qualify for the new mortgage. As of November 21, 2024, borrowers with uninsured mortgages may be exempt from the prescribed minimum qualifying rate (MQR) set by OSFI when making a straight switch at renewal between federally regulated lenders, provided there is no increase to the mortgage amount or amortization.


Financial Benefits of Breaking Early


Breaking a mortgage early may result in interest savings if market rates have dropped and the borrower refinances into a lower rate. However, savings depend on the full cost of penalties and fees and may be reduced or eliminated if those costs are high.


Alternative Solutions to Breaking Your Mortgage


Alternatives may include:

● porting the mortgage to a new property,

● renegotiating or renewing early,

● blend-and-extend options, or

● making prepayments within permitted limits.


Availability and suitability depend on the mortgage agreement and lender policies.


Final Thoughts


Breaking a mortgage contract is a significant financial decision. Understanding penalties, fees, alternatives, and qualification requirements can help ensure the decision aligns with long-term financial goals. Speaking with a lender, mortgage professional, or financial advisor can provide additional clarity before taking action.

 

When the OSFI minimum qualifying rate applies to uninsured mortgages at federally regulated lenders, borrowers must qualify at the greater of the lender’s contractual mortgage rate plus a buffer, or the minimum qualifying rate set by OSFI at that time.


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I am a Victoria-based local realtor with eXp Realty. My commitment to honesty, integrity, loyalty, and hard work have been essential pillars for me because they drive a high standard of excellent service for my clients. Helping you realize your dream is my goal!


I service Vancouver Island, but my focus is on Victoria, Sooke, Saanich, Malahat, Shawnigan Lake, Cobble Hill, Duncan, and the rest of the Cowichan Valley.



 
 
 

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