Mortgage Prepayment Penalty When Selling Before Your Term Ends

If you sell your home before your mortgage term ends, you will usually be paying off the loan early. Lenders often charge for that, and the amount can be a few thousand dollars or much more.

This article explains how the penalty is generally calculated, what options may reduce it, and how timing your sale can matter. Your own contract controls, so read it or ask your lender before you commit to a date.

How the penalty is calculated

The Financial Consumer Agency of Canada says a prepayment penalty is usually the higher of two amounts: three months' interest on the balance owed, and the interest rate differential, often called the IRD.

Lenders typically use the IRD when your current rate is above the current market rate and the contract was signed less than five years ago. The IRD compares total remaining interest on the term at two rates: the posted rate when you signed, or your contract rate, and the current posted rate for a similar term, or that rate minus your original discount.

The agency's example shows the difference. On a $200,000 balance at 6% with 36 months left, the IRD was $12,000 against $3,000 for three months' interest, so the penalty was $12,000. An administration fee may also apply.

The cost depends on the amount prepaid, the months left in the term, interest rates and the lender's own method. Banks often publish penalty calculators, which can give you an estimate.

The five-year rule in the Interest Act

There is a federal rule that limits what you can be charged on older mortgages. For a mortgage not due for more than five years from its date, the borrower may pay it off after the five years by paying principal and interest to the payment date plus three months further interest in lieu of notice, and after that no further interest may be charged (Interest Act, s. 10(1)).

This does not apply to everyone. Section 10(2) excludes mortgages given by corporations and certain prescribed mortgages. If your term is shorter than five years, or your mortgage falls in an excluded group, ask a lawyer how the rule applies to you.

Ways to avoid or reduce a penalty

The agency lists porting when buying a new home as a way to avoid breaking the contract, and suggests asking your lender whether your mortgage can be ported. Porting depends on the lender's conditions, and you may still need to qualify for the new home, so ask early.

Some lenders also restrict prepayments close to the contract break date. Check for this before you assume you can use your privileges at the last minute.

Whether a buyer can take over your existing mortgage depends on your lender's consent and your contract. It is not something you should assume, so raise it with your lender and a lawyer before promising it to a buyer.

Planning the sale around the penalty

The penalty is a cost of selling, so it belongs in your numbers from the start. It reduces what you walk away with, and it can influence your closing date, your asking price and whether porting makes sense if you are buying again.

• If you are buying another home, compare porting against paying the penalty and starting a new mortgage.
• If your term ends soon, ask whether a later closing date would avoid the penalty.
• If you hold a variable or open product, check whether prepayment is allowed without penalty.
• Leave a margin in your budget for administration fees.

What to do next

• Find your mortgage contract and note your rate, balance, term end date and prepayment privileges.
• Ask your lender for the exact penalty for your planned closing date, in writing.
• Use your bank's penalty calculator for a rough estimate.
• Ask whether the mortgage can be ported and what conditions apply.
• Check whether your lender restricts prepayments near the contract break date.
• Tell your lawyer about the penalty so the payout is accounted for at closing.

Frequently asked questions