Nearly 60% of outstanding mortgages at Canadian banks will come up for renewal within the next three years, and homeowners could face a significant increase in monthly payments if interest rates do not fall, according to an RBC Capital Markets market update released at the end of October 2023. Depending on when a mortgage matures, monthly payments could rise by roughly 33% to 84%. If your mortgage renewal is approaching, you may already be watching five-year fixed and five-year variable rates closely. You might be wondering: should you renew early, or switch lenders to secure a more favourable rate?
One important factor to weigh is whether your mortgage is closed. If you break a closed mortgage contract before the agreed term ends, your lender will typically charge a prepayment or mortgage penalty. A mortgage penalty calculator can estimate those fees so you can decide if breaking the mortgage makes financial sense. This is especially useful for first-time home buyers who may find a better rate after signing their initial mortgage.
What is a mortgage penalty?
When you take out a mortgage, you and your lender agree on a term—the fixed period the contract remains in effect, which commonly spans several months up to five years or more. If you end the mortgage before the term expires, the lender usually charges a fee known as a mortgage prepayment penalty. Typical situations that lead to a prepayment penalty include:
- Making an additional lump-sum payment larger than your contract allows
- Transferring your mortgage to another lender before the term ends
- Paying off the entire mortgage balance early, for example when you sell your home
What factors determine mortgage penalties?
A mortgage penalty calculator uses several factors to estimate how much it will cost to break a mortgage early. Key inputs typically include:
- Your lender and the province or territory where you live
- The start date and original length of your mortgage term
- Whether your mortgage rate is fixed or variable
- Your current mortgage interest rate
- The outstanding balance remaining on your mortgage
Enter accurate details into a mortgage penalty calculator to get a realistic estimate. Keep in mind these figures are estimates based on lender rules and the mortgage terms you provide; final amounts may vary once the lender calculates the penalty.
How are penalties calculated: variable vs fixed rates?
The method used to calculate a prepayment penalty depends heavily on whether your mortgage has a variable or fixed interest rate. For variable-rate mortgages, lenders commonly charge three months’ interest on the remaining mortgage balance. For fixed-rate mortgages, lenders usually calculate the penalty two ways and charge the higher amount:
- Three months’ interest on the outstanding balance, or
- The interest rate differential (IRD), which reflects the difference between your current contract rate and the rate the lender would charge for the remaining term if they were lending the funds today
The IRD can be substantial when current market rates are much lower than your original rate, which is why fixed-rate borrowers should always check both calculations before deciding to break a mortgage.
When might it make sense to pay the penalty?
Even if a mortgage penalty calculator returns a sizable fee, breaking a mortgage can still be worthwhile in some circumstances. The essential step is to compare the prepayment penalty with the savings you would realize from switching to a lower rate. Consider these points when evaluating your options:
- Calculate the total interest savings over the remainder of your mortgage term after switching to the new rate.
- Factor in any additional costs, such as legal or administrative fees, associated with switching lenders or refinancing.
- Assess your long-term plans: if you expect to sell or refinance shortly, breaking the mortgage may not be cost-effective.
Using a mortgage penalty calculator together with a mortgage affordability or mortgage payment calculator will help you make an informed choice. Doing the math is the best way to determine whether paying a prepayment penalty today saves you money over the life of the loan.
A note about the mortgage penalty calculator
Results from a mortgage penalty calculator are based on the criteria you provide and the lender’s published rules. The actual rate a lender offers may differ when you apply, and rates can vary with an applicant’s credit history. A real mortgage decision will also consider qualification criteria such as debt-servicing ratios, credit score, property value and other underwriting details. Example results do not include homeowners insurance or property taxes. Default rate assumptions often reflect an excellent credit history, purchase of a single-family home under CAD$1,000,000 for owner-occupancy, and a 20% down payment.
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