Breaking a Mortgage Early in Ontario: How Penalties Work

Plans change. You may need to sell mid-term because of a move, a separation or a job change, or you may want to refinance to change your payments. In each case, the lender will usually expect you to pay something to leave the mortgage contract early.

That charge can be significant, and it can change whether a sale or refinance makes sense. This article explains the two common ways the penalty is set, the exceptions to watch for, and what to check before you commit.

Why a penalty applies

A fixed-rate or fixed-term mortgage is a contract. The lender agreed to lend you money at a set rate for a set term, and it expects to earn that interest. If you pay the mortgage off early, the lender usually charges a penalty to make up for what it loses.

If you break a mortgage contract, the penalty is usually the higher of three months' interest on what you still owe or the interest rate differential, often called the IRD. Because it is the higher of the two, you cannot assume the smaller number will apply to you.

Three months' interest versus the IRD

Because the IRD can be the larger figure, ask your lender how it would work out the amount for your mortgage. Your mortgage agreement is the place to look for how the penalty is worked out. Federally regulated lenders must set out prepayment privileges and penalties in an information box at the start of the mortgage agreement. How a provincially regulated or private lender sets this out depends on your contract, so ask where to find it.

Ask the lender for a written payout figure with the calculation shown. A figure quoted by phone is only an estimate, and it can change with your payout date.

Ways to reduce or avoid the penalty

• Port the mortgage. A portable mortgage lets you transfer your existing balance, interest rate and terms to a new home when you sell and buy, which avoids breaking the contract. Whether you can port, and on what conditions, depends on the lender.
• Watch for a cheaper home. If the new home costs less than the amount of the mortgage, you may still pay a prepayment penalty.
• Check the five-year rule. If your mortgage term is longer than five years, then after five years from the mortgage date you may pay off the principal and interest plus three months' further interest, and no further interest is chargeable.
• Know the exception. That five-year right does not apply to a mortgage given by a corporation, or to certain prescribed mortgages given by prescribed entities.
• Wait for renewal. If your term ends soon, timing the sale or refinance for the maturity date may avoid the charge. Your contract will say what applies.

Questions to ask before you sell or refinance

• What is the exact payout amount, and which method does it use?
• Does my mortgage allow porting, and what are the conditions?
• Does the penalty change if I close on a different date?
• Does my contract allow any prepayment without penalty?
• Is my mortgage term longer than five years, and is the borrower a corporation?
• How does the penalty compare with the savings from a new rate?

If you are refinancing, add the penalty to your other costs. A lower rate may not be worth it if the penalty absorbs most of the saving. A mortgage professional or accountant can run the numbers with your actual figures.

What to do next

Find your mortgage agreement and any renewal letter, and read the prepayment section first. Then ask the lender for a written payout statement for your likely closing date.

If you are selling, tell your real estate lawyer about the mortgage early so the payout can be built into the closing. If the contract is unclear, or the lender's figure looks different from what your agreement says, a lawyer can review the wording before you sign anything.

Frequently asked questions