Mortgage Penalty When Selling Your Home in Ontario: Discharge Explained

If you are selling a home that still has a mortgage, that mortgage has to be paid out on closing so the buyer gets the property free of it. Many sellers are surprised to learn that the lender may charge a penalty for ending the mortgage before the term is up.

This article explains in plain terms how the penalty is usually worked out, the few situations where the law gives you a way out, and how the discharge fits into your closing. It is general information. Your own mortgage contract controls the details, so read it or ask your lender before you list.

Why selling can trigger a penalty

Paying off an entire mortgage early, including because you sell the home, can trigger a prepayment penalty. The penalty is the lender's charge for ending the loan before the agreed term finishes. It is not a government fee, and it is separate from the other costs of selling your home.

Most mortgage terms are five years or less. In a typical one-to-five-year term, the law does not give you a right to pay out for a fixed small charge, so the penalty set out in your contract usually governs the payout on a sale. Corporate borrowers and certain other prescribed borrowers are treated differently under the federal rule.

How the penalty is usually calculated

A prepayment penalty is usually the higher of three months' interest on what you still owe or the interest rate differential, often called the IRD. Lenders usually use the IRD when your rate is higher than current rates and you signed less than five years ago.

The Financial Consumer Agency of Canada gives this example: on $200,000 at 6% with 36 months left and a posted rate of 4%, three months' interest is $3,000 and the IRD is $12,000, so the penalty is $12,000, plus possibly an administration fee. Lenders use different formulas for the comparison rate, so your own number may differ from a simple example.

When the law gives you a right to pay out

Under the federal Interest Act, where a mortgage on real property is not payable until more than five years after its date, the borrower may, after five years, pay the amount due plus three months' interest in lieu of notice, and no further interest is chargeable. Ontario's Mortgages Act has a matching five-year rule: principal and interest owed plus three months' further interest.

The Mortgages Act also says a borrower paying principal early must give at least three months' notice in writing unless they pay three months' interest in lieu of notice. Whether these rules help you depends on the length of your mortgage and who the borrower is, so have a lawyer read your mortgage before you assume either way.

Porting and other ways to reduce the hit

Porting means moving your existing mortgage to a new home. It is only an option if you are buying another home, and you should ask your lender whether it is allowed. Timing between the sale and the purchase, and the terms of the ported mortgage, are matters to settle with the lender directly.

• Ask the lender for a written payout statement showing the balance, interest and penalty.
• Ask whether porting is available and on what conditions.
• Ask whether an administration fee applies on top of the penalty.
• Compare the penalty with the cost of waiting, if your term is close to ending.

How the discharge is handled at closing

How the payout and the release of the lender's registered mortgage are handled on closing depends on your lender and your situation, so it is worth confirming the steps with your lawyer well ahead of time. The amount paid to the lender comes off what you receive from the sale. This is why you want the penalty confirmed well before closing day, not on it.

If a mortgagee cannot be found, or a proper discharge cannot be obtained without undue delay, the court may permit payment into court and order the mortgage discharged. Registering that order has the same effect as registering a certificate of discharge signed by the mortgagee. This is uncommon and takes legal steps, so a lawyer should guide it.

What to do next

• Find your mortgage contract and note the term, rate and prepayment wording.
• Ask the lender for a payout quote for your expected closing date.
• Ask about porting if you are buying another home.
• Tell your lawyer about the mortgage as soon as you list, so the discharge is arranged in good time.
• If the lender is hard to reach or the mortgage is old, raise it with your lawyer early.

Frequently asked questions