Mortgage Prepayment Penalties When Selling Your Home in Ontario

If you sell your home before your mortgage term ends, your lender may charge a penalty for paying out early. For some sellers it is a modest amount. For others it is large enough to change the timing of a sale.

This article explains how penalties are generally calculated in Canada, what can reduce them, and what to ask your lender. Formulas differ by lender and contract, so your own mortgage terms and the lender's payout statement are what count.

How a closed-mortgage penalty is usually calculated

A closed-mortgage prepayment penalty is usually the higher of three months' interest or the interest rate differential, known as the IRD. Lenders generally use the IRD when your mortgage rate is above the current rate and the contract was signed less than 5 years ago. IRD comparisons are typically based on the lender's posted rates.

In plain words, the IRD is the lender's estimate of the interest it loses when you leave a higher rate early and it can only re-lend at a lower one. Because lenders choose their own comparison rates, two lenders can produce very different penalties on similar mortgages.

This is why the details of your own contract matter so much. When you speak to your lender, ask which comparison rate it uses and which remaining term it applies. Those two choices drive the result, and a federally regulated lender must be able to explain them to you.

What your lender must tell you

The federal Code of Conduct on mortgage prepayment information applies to federally regulated financial institutions. Under it, lenders must explain how they calculate the prepayment charge and how they choose the IRD comparison rate. When a borrower confirms a prepayment, the lender must give a written statement of the calculation, including the comparison rate and remaining term used. On request, lenders must give a written statement of the current charge through a toll-free line.

Whether the Code covers your lender depends on the kind of lender you have, so it is worth asking. Either way, ask for the figure before you list your home, and again closer to closing, since the amount can change with your remaining term and with rates.

Ways to lower the cost

• Use your yearly prepayment privileges to reduce the balance the penalty is based on.
• Port the mortgage, which means keeping its rate and terms for a new home.
• Wait until the end of the term, if your timing allows.

Porting only helps if you are buying another home, and each lender sets its own conditions. Ask whether the lender will approve the new property and how the dates must line up with your sale and purchase.

Using your prepayment privileges is worth a conversation with your lender early on, because a smaller balance means the penalty is worked out on a smaller amount. How much room you have depends on your contract.

Open mortgages, fees and the five-year rule

An open mortgage can be broken without a prepayment penalty. Even so, sellers breaking a mortgage may face administration, appraisal, reinvestment and discharge fees, and may have to repay any cash back received.

If your mortgage is not due until more than five years after it was made, you may pay it off at any time after five years by paying the principal and interest owing plus three months' further interest in lieu of notice. Ontario's Mortgages Act gives the same right. This can matter if you have a longer-term mortgage that would otherwise carry a large IRD.

Some buyers ask whether they can take over your existing mortgage instead. Whether that is possible depends on your lender and your mortgage terms, so ask the lender directly and do not count on it when pricing your sale.

In the less common situation where the mortgagee cannot be found, or a discharge cannot otherwise be obtained, the Mortgages Act allows the court to permit the amount owing to be paid into court and to order the mortgage discharged. A registered court discharge order has the same effect as a discharge signed by the mortgagee. A lawyer can tell you whether this applies to your situation.

What to do next

• Read your mortgage contract for its prepayment terms, privileges and porting rules.
• Ask your lender for a written statement of the current prepayment charge and how it was worked out.
• Find out whether your mortgage is open or closed and whether the five-year rule may apply.
• Ask whether administration, appraisal, reinvestment or discharge fees, or repayment of cash back, could apply to you.
• If you are buying again, ask about porting before you sign a sale agreement.
• Share the payout figure with your lawyer so it is built into your closing numbers.

Frequently asked questions