3 Month Interest Penalty

Financial institutions and lenders that allow borrowers to break mortgages often charge individuals the greater of the Interest Rate Differential (IRD) or a three month interest penalty.

While the Interest Rate Differential is an amount calculated based on the difference between two interest rates, the three month interest penalty amount is simply three months interest on the outstanding amount on a borrower’s mortgage.  Lenders in some cases use arbitrary posted mortgage rates to calculate the three month interest penalty. Lenders do provide advance notice on how interest penalties are calculated, and this information is clearly available in the mortgage agreement one sign’s when the mortgage is originated.  How the calculations are made to break an existing mortgage is a lender’s own decision as there is no banking legislation in place that dictates how banks or lenders are to calculate breakage penalties. 

Individuals and borrowers comparing mortgage rates should also compare other features of the mortgages being presented.  As many Canadian’s break and/or refinance their mortgages, borrowers should ensure they understand the formula used for penalty calculations purposes. 

Financial institutions and lenders are in the business of making money.  However, in some circumstances, they will work with you in ways to reduce the prepayment charge.   Three month interest penalties can vary greatly from institution to institution.

Calculation of 3 Months Interest Penalty

                               B      

  A    X           _____________              × 3 months                 

                      12 months

A = Outstanding balance on mortgage

B = Annual interest rate on mortgage

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April 27, 2017

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