Most closed mortgages charge a payout penalty if you break the term early. Lenders typically
use the higher of:
1) Interest Rate Differential (IRD) – common on fixed rates
What it means: The lender compares your contract rate to a current rate for the time you have left in your term. If your rate is higher, they charge the difference for the remaining time.
Plain formula:
IRD ≈ (Your rate − Comparison rate) × Years left × Mortgage balance
⚠️ Methods vary. Some big banks use a “posted-rate/discount” method (they subtract your original discount from today’s posted rate), which can make the IRD larger (Thousands of dollars larger) than using actual current rates. Many non-bank lenders use a more
straightforward comparison rate.
2) Three Months’ Interest used for variable rates and as a floor on many fixed
Plain formula:
3-month interest = Mortgage balance × Your rate × (3 ÷ 12)
Lenders charge the higher of IRD or 3 months’ interest (except many variable-rate mortgages, which are usually 3 months’ interest only).
Quick example (numbers just to illustrate)
Balance: $400,000
Your rate: 5.00% fixed
Time left: 2 years
Today’s 2-year comparison rate: 4.00%
IRD (simple method):
(5.00% − 4.00%) × 2 × $400,000 = $8,000
3 months’ interest:
$400,000 × 5.00% × 3/12 = $5,000
Penalty charged: higher of the two = $8,000
If a “posted-rate/discount” IRD is used:
Say your original discount was 2.00% and today’s 2-year posted is 5.50% → comparison
becomes 3.50% (5.50 − 2.00).
IRD = (5.00 − 3.50) × 2 × $400,000 = $12,000 (noticeably higher).
Tips to avoid surprises
Ask your lender for a written penalty quote and how they calculate IRD (posted-rate/discount vs. straight comparison rate).
Check your terms: fixed vs. variable, open vs. closed, and any prepayment privileges (lump sums/payment increases can reduce a penalty if applied before payout).
Time your move: penalties usually shrink as you get closer to maturity.
If you want, send me your balance, rate, and months left, and I’ll estimate both methods and show you ways to reduce or avoid the penalty.
Feel free to text, call, or email anytime with questions.
