What are the penalties for breaking variable versus fixed mortgages?

By: Renee Sylvestre-Williams on May 4, 2021
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Here’s the thing about mortgages: no matter if they’re variable or fixed, if you decide to break them, you will pay a fee known as a prepayment penalty.  

When you break a mortgage, your lending institution will lose out on the interest payments expected over the length of your mortgage. The penalty is the price you pay for breaking the contract. The amount you’ll pay depends on the type of mortgage: variable or fixed.

Breaking a mortgage early can be tempting, especially when you can get a lower interest rate and save thousands of dollars over several years or decades. And that might be worth the upfront penalty costs. But before you call up your mortgage broker or your bank, let’s look at how these break-early penalties work and when it makes sense for you to break your mortgage. 

When you should consider breaking your mortgage

This is where you need to do the math. When you run the numbers, you want the penalty you’d have to pay to be less than the benefits you’ll gain, or the amount of money you’ll save over the length of your mortgage. If the penalty you’re paying is more than what you’ll save during your mortgage term, then it’s not worth breaking it for a lower rate. 

Your lender may calculate your prepayment penalty using factors such as: 

  • The number of months left in your mortgage term
  • The remaining balance on your mortgage
  • Current interest rate you’re paying on the mortgage
  • Current posted interest rate offered for a mortgage with the same term as what’s left on your mortgage

Now let’s look at the amount you’ll pay in penalties. 

Prepayment penalties: variable versus fixed

When it comes to breaking a mortgage, variable-rate mortgages tend to be the more attractive option. When you break a variable-rate mortgage, you will usually have to pay a penalty of three months worth of interest on what you still owe on the loan. 

With fixed-rate mortgages, however, your lender will calculate two things: three months’ interest and what’s called the interest rate differential (IRD).

The IRD is typically calculated using two interest rates — your current interest rate, and the rate your lender could charge today on a mortgage with a similar term as what’s remaining in your mortgage. The difference between the two is the IRD.

With most fixed-rate mortgages, you’ll have to pay the greater of the two options if you decide to break your mortgage. So if the three months of interest is more than the IRD, you’ll pay that amount as your penalty. And vice versa.

Head to our mortgage page to view current rates on variable- and fixed-rate mortgages.

How to minimize prepayment penalties

You will have to pay some sort of penalty for breaking your mortgage but there are ways to reduce — and in some cases, maybe even avoid — these fees:

  • Do the math yourself. Your lender will do its own calculation but don’t rely solely on their numbers. As Ellen Roseman writes in this article, the big banks have been subject to class action lawsuits for how they calculate mortgage prepayment penalties that led to massive fees for mortgage holders. 
  • Port your mortgage. If you’re breaking your mortgage so you can buy a new home, porting your current mortgage to the new home can save you from paying penalty fees because you’re not breaking the mortgage. Ask your lender if your mortgage is portable. (This is one reason why you should consider getting a mortgage with this flexibility.) 
  • Wait until the end of your term to walk away. If you can wait, break your mortgage when you’re near the end of your term. For instance, don’t break it in the first year, but if you’re in the fourth year of a five-year mortgage term, then it might make sense because you’ll pay less in interest penalties. 
  • Max out prepayments. If you think at some point in the future you might break your mortgage, then take advantage of prepayments now. You’ll pay down your mortgage faster so when you do break it, you’ll have a smaller balance, which means less money lost to penalties.
  • Compare the market. When it comes time to renew your mortgage, it’s in your best interest to see what else is out there. Use online comparison tools to compare mortgage rates from a number of providers to find the best rate for your needs.

Whatever you decide to do, run the numbers yourself and compare them to those provided by your lender. You want to make sure that you’re going to benefit from breaking a mortgage, not just pay a lot of money in fees. For that reason, variable-rate mortgages are usually considered the less risky option.