A prepayment penalty is a fee that your lender may charge if:
Your lenders may call the prepayment penalty a prepayment charge or breakage cost
Prepayment penalties can cost thousands of dollars. It's important to know when they apply and how your lender calculates them.
You can base your estimate of your prepayment penalty on factors such as:
When prepayment penalties apply
If you have a closed mortgage, you'll need to pay a prepayment penalty if you:
If you have an open mortgage, you can make a prepayment or lump-sum payment without paying a penalty.
Find out about open and closed mortgages and how to choose a mortgage that is right for you.
How lenders calculate prepayment penalties
The way your prepayment penalty is calculated varies from lender to lender.
The interest rate differential is the difference between the interest rate on your current mortgage term and today’s interest rate for a term that is the same length as the remaining time left on your current term.
Review your mortgage contract to find out exactly how your lender will calculate your prepayment penalty. Check with your lender for the actual amount. Ask your lender to explain anything you don’t understand.
You may also have to pay an administration fee to make a prepayment.
Prepayment penalties on discounted interest rates
If you negotiated a discounted interest rate, the calculation of the interest rate differential will depend on the lender and the terms of your mortgage contract.
To calculate your prepayment penalty, lenders may use:
Paying your prepayment penalty
Your lender may allow you to add a prepayment penalty to your mortgage balance. This means you’ll pay interest on your prepayment penalty.
You can also pay your prepayment penalty up front.
Tips to reduce or avoid prepayment penalties
Consider the following options to reduce the amount of money you may pay in penalties.
Make full use of your prepayment privileges
Make full use of your prepayment privileges every year. Any future prepayment penalties will be based on a lower mortgage balance.
Make a lump-sum prepayment before you break your mortgage. Although, some lenders will restrict your ability to prepay if you're too close to the date you break your contract.
Read your mortgage contract carefully. Ask questions about anything you don't understand.
Wait until the end of your term to prepay
Consider waiting until the end of your term to prepay if your prepayment penalty will be a large amount. You can then make a lump-sum prepayment without penalty.
Port your mortgage
If you're buying a new home, ask your lender if you can port your mortgage. This means taking your existing interest rate and terms and conditions with you to your new home. It saves you from breaking your mortgage contract and getting a new one
Shop around when you renew your mortgage. Contact various lenders and mortgage brokers to check if there is a better mortgage option that will offer you more flexibility to make prepayments.
Questions to ask your lender about prepayments
When shopping around for a mortgage, look for flexibility in prepayment privileges.
Ask your lender the following questions before signing a mortgage contract:
What you need to know about prepayment penalties
If a federally regulated financial institution, such as a bank, issues your mortgage, the following details must appear in an information box at the beginning of your mortgage agreement:
Your lender must tell you how they will calculate your prepayment penalty. Your lender must also tell you what factors are used to determine the penalty. These details must be clear, simple and not misleading.
Read your mortgage contract carefully. Make sure you understand the details about penalties before you sign your contract. Ask questions about anything you don't understand