What You Need to Know About Early Payment Penalties

2021-07-27 | 13:37:39

Many mortgage borrowers hyperfocus on the lowest rate – and that can cost them big-time!

For a variety of reasons, the most popular mortgage term in Canada has long been the five-year term – it tends to offer the best balance of insulation from short-term rate fluctuations and a competitive rate.  However, focusing on the rate that your paying – to the exclusion of all other considerations – can actually work against your best interests.

One example of this can arise if you need to break your current mortgage before its normal renewal date.  When this happens, your lender will assess an early repayment charge, adding the amount of the charge to your existing balance.  (The lenders call this a “penalty”, but I don’t like that choice of word – it is chosen to imply something negative which people will avoid at all costs, even if it is to your advantage to pay it.  But I digress.)

The charge the lender levies will be the greater of three-months’ interest on the remaining balance or what is called an Interest Rate Differential (IRD), which is a calculation of how much interest the lender stands to lose when a borrower pays off their mortgage sooner than expected.

However, how the IRD is calculated can vary between lenders.  To illustrate, let’s look at an example:

In May 2018, Bill & Melinda bought a home in Ottawa for $750,000, taking out a $675,000 mortgage amortized over 25 years.  (Including the CMHC premium, their starting balance was $695,925.)

In July 2021, Bill & Melinda filed for divorce and put the matrimonial home on the market.  Two of the possible early repayment charge scenarios they could face are these:


Interest rate they got:  3.74%
Mortgage payment:  $3,563/month

Projected savings over 5 years:  $3,360
Actual savings to July 2021:  $2,128

Early repayment penalty:  $31,500


Interest rate they turned down:  3.89%
Mortgage payment:  $3,619

Early repayment penalty:  $13,300

Bill and Melinda thought they were getting a great deal when they took advantage of a special offer that saved them 0.15% as compared to the mortgage offered by a competitor.  But three years later, when life circumstances dictated that they had to pay that mortgage out early, their choice to chase the lowest rate ended up costing them over $18,000 in additional charges compared to what they’d have paid with the competitor, making the $2,100 they’d saved to that point look insignificant by comparison.

This is not an uncommon situation.  In fact, approximately 70% of Canadian five-year mortgages are broken before their renewal date, with a five-year mortgage actually only lasting an average of 38 months!  There are many reasons this can happen, including:

  • Divorce / Separation
  • Job Loss / Income Reduction
  • Require equity for unexpected expenses (i.e., home repairs)
  • Need to consolidate debt to free up cash-flow
  • Require equity for a child’s education
  • Require equity for investment opportunity
  • … or simply a desire to take advantage of lower rates

Mortgage professionals like me know our lenders’ policies as well as their rates.  We know which lenders calculate their early repayment charges like Lender #1, and which ones are more like Lender #2.  Working with an unbiased, independent professional (as opposed to someone on the payroll of a single lender) costs you nothing in situations such as these, but can potentially save you tens of thousands of dollars down the road.

TL;DR – Do you want the best rate, or the best mortgage?  Because they may not be the same thing.

Let’s start the conversation today to find the best mortgage for your unique situation!