Understanding Mortgage Prepayment Charges

The purpose of a prepayment charge is to compensate the lender for the economic costs it incurs when a prepayment amount exceeds the prepayment privileges permitted under the current mortgage contract. 

Prepayment charges are calculated differently depending on the type of mortgage you have.  

For a fixed-rate closed mortgage, the charge is the greater of

1.    three months’ interest on the amount prepaid based on your current interest rate;

or

2.    an interest rate differential (IRD) calculation for the remainder of the term based on the amount prepaid.

An IRD calculation takes the difference between the interest rate attached to your mortgage and compares it to the current interest rate charged by the lender for a new mortgage with a similar term.

The simplified IRD formula is as follows:

Mortgage Balance x ((Annual Interest Rate – Discounted Mortgage Rate*) /12) x Term Remaining = Simplified IRD Prepayment Charge

As an example, using a mortgage balance of $285,250, an Annual Interest Rate of 3.00%, and a Discounted Mortgage Rate of 2.50%, the prepayment charge equals:

$285,250.00 x (3.00% - 2.500%*)/12 x 31 (months remaining in term) = prepayment charge of $3,684.48

* Discounted Mortgage Rate is equal to the Current Interest Rate less any discount you received on your existing mortgage.

For complete details on the IRD calculation formula, please refer to your most recent annual mortgage statement.

For variable rate mortgages, the prepayment charge equals 3 months’ interest on the amount prepaid using your current interest rate.

The formula to calculate a three months’ interest charge is as follows:

(Mortgage Balance x Annual Interest Rate)/4 = Three Months’ Interest Prepayment Charge

As an example, using a mortgage balance of $285,250, and an interest rate of 3.00%, the prepayment charge equals:

($285,250.00 x 3.00%)/4 = prepayment charge of $2,139.38