Mortgage Pre-Payment Penalties

How do I estimate my mortgage pre-payment penalty using the interest rate differential?

If you’re paying out a closed fixed rate mortgage before the end of your term, you may be facing a significant prepayment penalty or fee from your lender. This can happen in the context of the sale of your property or a mortgage refinancing.

Most closed fixed rate mortgages have a prepayment penalty that is the higher of: (1) three months’ interest at your annual interest rate on the amount you want to prepay; and (2) the Interest Rate Differential or “IRD”. The IRD amount is equivalent to the difference between your annual interest rate and the current posted interest rate on fixed rate closed term mortgage with a term that is closest to the remaining term of your existing mortgage, less any rate discount you received on your existing mortgage, multiplied by the amount being prepaid, and multiplied by the time in years remaining on the term. The IRD can be a bit complex so we’ll run through a quick example.


Don and Stella own a home in Toronto. They have 28 months, or 2.33 years, remaining on the term of their closed fixed rate mortgage. They have a mortgage balance of $100,000 and are paying an interest rate of 5%. They received a 5 basis points discount off of the posted rate when they set up their mortgage. They have recently received a gift of $100,000 from Stella’s parents and would like to use it to pay off their outstanding balance. The current interest rate for a mortgage similar to theirs is 3.05%.

Step 1

Don and Stella’s current annual interest rate expressed as a decimal = 0.05 [A]

Step 2

The current interest rate charged by Don and Stella’s lender on a mortgage that most closely matches their remaining term (3.05%) less Don and Stella’s discount (0.05%) = 0.03 [B]

Step 3

[A  –  B] =  C

[0.05 – 0.03] = 0.02

Step 4

The amount Don and Stella want to prepay = $100,000 [D]

Step 5

Term remaining on Don and Stella’s term = 28 months = 2.33 years [E]

Step 6

Estimated IRD penalty = [C x D x E] = [0.02 x 100,000 x 2.33] = $4,660

As you can see, the IRD mortgage prepayment penalty can be large even on a mortgage of only $100,000. Don’t just accept your penalty. Talk to your professional advisors about your options. For those of you in the Greater Toronto Area, contact us today.

Painting by Katerina Podolak · Rain in Camden Town