Breaking a closed mortgage usually results in a penalty. With a fixed mortgage, that penalty is typically the greater of 3-month’s interest or the interest rate differential (IRD).

The dreaded IRD has been debated here ad infinitum, but there’s one thing we haven’t covered yet. There is a subtle twist to some lenders’ 3-month interest penalties that many folks aren’t aware of.

When most people calculate a 3-month interest charge they do so by taking their mortgage balance, multiplying by their interest rate, and dividing by four.

That usually works…unless your lender calculates the penalty with a different rate than your contract rate.

Believe it or not, a few lenders (see below) jack up the rate they use to figure their 3-month penalties. These lenders will typically base your penalty on the posted rate at the time you closed the mortgage, instead of your actual rate.

Let’s examine the difference this makes to the typical mortgage holder.

The average mortgage balance in Canada is $170,000, according to CAAMP. The average mortgage rate is 3.64%, or 1.77% off posted rates.

Therefore, the penalty for a “typical” mortgagor being assessed a 3-month interest charge would be about $1,547.

By contrast, the 3-month penalty based on *posted* rates would be almost $2,300.

In other words, lenders who use arbitrary posted rates to calculate their 3-month interest penalties drain the typical borrower of an additional $752 based on a 20-year amortization. That is:

- About 49% more than other lenders
- Roughly equivalent to paying a 10 basis points higher rate over five years.

And with more than 50% of long-term mortgage holders breaking and/or renegotiating their mortgage before maturity, penalty calculations aren’t something to blow off.

In case you were wondering, there is no legislation prohibiting this practice.

“There is nothing in the Bank Act (or Interest Act) that stipulates exactly what interest rate should be used in the calculation of a mortgage prepayment penalty,” says Natasha Nystrom, Communications Officer at the Financial Consumer Agency of Canada. “The calculation itself is a business decision.”

Theoretically, a lender can use almost any rate short of usury to calculate your penalty, as long as it tells you in advance.

“The Bank Act does require that all Federally Regulated Financial Institutions (FRFI) initially disclose the manner in which their penalty is calculated as well as a description of the components included in the calculation of the penalty,” Nystrom adds.

Here’s what we’d take away from all this…

When you’re comparing two mortgages and the rates are equal, all other terms are rarely equal. The method your lender uses for penalty calculations is one of many reasons why the rate you get doesn’t determine the interest you pay.

**Rates used to calculate 3-month interest penalties on fixed mortgages:**

- ATB Financial – Contract rate
- BMO – Contract rate
- CIBC –
*Posted rate* - Coast Capital – Contract rate
- First National – Contract rate
- Home Trust – Contract rate
- HSBC – Contract rate
- ING Direct – Contract rate
- Manulife – Contract rate
- MCAP – Contract rate
- Meridian Credit Union – Contract rate
- National Bank –
*Posted rate* - Scotiabank – Contract rate
- Street Capital – Contract rate
- RBC – Contract rate
- TD Bank – Contract rate
- Vancity – Contract rate

The “contract rate” refers to the rate you actually pay.

The “posted rate” refers to the non-discounted posted rate at the time you closed your mortgage.

The above list was compiled based on information obtained by surveying lender call centre reps and/or reviewing standard charge term documents. These rates apply to prime mortgages only and are believed accurate. If you have different information, please let us know. Moreover, if you know of other lenders who calculate 3-month penalties based on posted rates, feel free to leave a comment below.

Note: Many lenders let you avoid penalties by porting your mortgage or using a “same-term blend and increase.” Contact your mortgage planner for details.

*Rob McLister, CMT*