Three Months' Interest

Three months' interest is the prepayment charge most Canadian lenders apply when a borrower pays off or breaks a variable-rate mortgage before the term ends. Rather than the larger interest rate differential (IRD) that usually applies to fixed-rate mortgages, the penalty is calculated as three months of interest on the outstanding balance at the contract rate.

How the charge is worked out

The lender takes the remaining mortgage balance and the contract rate, then estimates what interest would accrue over roughly three months. Because a variable-rate mortgage is priced off prime rate, the contract rate at the moment of payout drives the size of the charge: when prime rises, the penalty rises with it, and when prime falls, the penalty falls.

Variable-rate mortgage: typically three months of interest, with some lenders using a posted rate rather than your discounted rate.
Fixed-rate mortgage: typically the greater of three months of interest or the IRD, which can be substantially higher when rates have dropped since you signed.
Open mortgages: usually no charge at all, which is why they carry a higher rate.

The exact formula lives in your mortgage commitment and the lender's standard charge terms, so the only reliable figure is the payout statement your lender provides.

Why it matters to borrowers

Breaking a term is common when a home is sold, a refinance is planned, or a borrower wants to move to another lender. Knowing the penalty method changes the math on whether a refinance is worthwhile. A borrower on a variable-rate mortgage usually faces a smaller exit cost than a neighbour on a comparable fixed-rate mortgage, which is one reason variable-rate products are often described as cheaper to leave.

Canadian law also restricts how much interest a lender may charge when a mortgage is paid off after a set number of years, and the federal regulator expects lenders to disclose how a prepayment charge is calculated. Ask for the calculation in writing before you authorize a payout.

Reducing or avoiding the charge

Use prepayment privileges first, since they usually carry no charge.
Ask about porting the mortgage to a new property or blending the rate into a new term.
Time a move to the renewal date, when switching lenders is normally free of penalty.

Estimating the number before deciding is straightforward with a mortgage penalty calculator, but treat any estimate as approximate until the lender confirms it.

Frequently asked questions

Is three months' interest always the penalty on a variable-rate mortgage?

It is the most common method, but not a guarantee. Some lenders use a posted rate instead of your discounted rate, and a few apply a different formula. The calculation that applies to you is stated in your mortgage commitment, so ask the lender for the exact figure before you break the term.

Is three months' interest bigger than the interest rate differential?

Usually it is smaller. The interest rate differential compares your rate with the lender's current rate for a similar term, so when rates have fallen since you signed, the IRD can far exceed three months of interest. That gap is why fixed-rate mortgages often cost more to break than variable-rate ones.

Can I avoid paying a penalty altogether?

Sometimes. Open mortgages generally carry no prepayment charge, prepayment privileges let you pay down part of the balance without one, and porting or blending the mortgage into a new term may avoid it entirely. Switching lenders at renewal is normally penalty-free. Confirm the rules with your lender before acting.