How Prepayment Penalty and Early Repayment Rules Work in Canada

A prepayment penalty is a fee some lenders charge when you pay a loan off early or pay more than your contract allows.

By Promissory.ca Editorial Team Reviewed against official Canadian sources Last updated: 2026-09-16

A prepayment penalty is the charge a lender applies when you repay a closed loan faster than the contract permits — paying the balance off early, raising your regular payment above the allowed limit, or making a lump sum larger than your annual prepayment privilege. It is separate from discharge and administration fees, which cover paperwork and registration when a mortgage is paid out.

Lenders charge it because a fixed-rate loan is priced on the assumption that the money stays out for the full term. Repaying early may force the lender to relend at a lower rate, and the penalty offsets that gap.

Open versus closed loans

An open loan can be repaid in whole or in part at any time without penalty, but it carries a higher rate. A closed loan trades that flexibility for a lower rate. Most Canadian mortgages are closed; credit cards and many lines of credit are open by design.

How prepayment penalties are calculated

For mortgages, two methods dominate. Which one applies — and which rate the lender plugs into it — is where borrowers get surprised.

Three months' interest

The lender multiplies the outstanding balance by your contract rate and charges the equivalent of three months of interest. It is simple, predictable and typical on variable-rate mortgages and shorter terms. Because it does not depend on where rates have since moved, you can estimate it before requesting a payout statement.

Interest rate differential

An interest rate differential, or IRD, compares your contract rate with the lender's current rate for a term similar to the time left on your mortgage. The difference is multiplied by the remaining balance and remaining term. A small gap over a long remaining term can produce a penalty many times larger than three months' interest, which is why IRD penalties generate the most complaints. Whether the lender uses a posted or discounted comparison rate, and how it rounds the remaining term, can change the outcome substantially.

Fixed versus variable rate

Closed fixed-rate mortgages usually carry the greater of three months' interest or the IRD, so the IRD generally governs. Variable-rate mortgages typically use three months' interest only. If you are choosing between the two, the penalty you might pay later is part of the true cost, not just the advertised rate.

Prepayment penalties by loan type

The table below summarises how early repayment is usually handled — your own agreement always governs.

Prepayment privileges: the room your contract gives you

Most closed mortgages include a prepayment privilege: the amount you can pay each year on top of your regular payments without triggering a penalty. It is usually expressed as a percentage of the original principal and resets annually on a date set by the contract. Typical features include:

• Increased payments: raising your regular payment by a set percentage, or doubling it.
• Annual lump sums: a payment up to the privilege limit, sometimes cumulative.
• Frequency changes: switching to accelerated biweekly or weekly payments, which trims the balance faster.
• Reset dates: the anniversary on which unused privilege refreshes, and whether it follows the closing date, funding date or calendar year.

Using the privilege consistently is the cheapest way to shorten a mortgage. If a lump sum would exceed the limit, ask for the penalty figure first and consider splitting it across two privilege years.

Payday loans and high-cost credit

Payday lending sits outside ordinary prepayment logic. The Criminal Code sets the criminal rate of interest at 35% APR, reduced from 48%, but payday loans in provinces with a payday lending regime are permitted under a cost cap of $14 per $100 borrowed, a dishonoured-payment fee capped at $20, and a maximum loan of $1,500. Quebec does not permit payday lending; the maximum rate of credit there is 35% per year.

The FCAC illustrates that a 14-day $500 payday loan at $14 per $100 costs $70, roughly 365% APR. Because the fee is charged up front and the term runs only to your next payday, repaying a few days early does not normally reduce what you owe.

Where early repayment usually costs nothing

• Credit card balances — interest stops on the amount you clear.
• Lines of credit and other revolving products, where interest is calculated daily.
• Open mortgages, and any loan the contract describes as open.
• Instalment loans whose agreement states there is no prepayment charge.

Instalment means two different things

A loan instalment is a scheduled payment; a tax instalment is a prepayment of income tax. The Canada Revenue Agency requires quarterly individual tax instalments by 15 March, 15 June, 15 September and 15 December, and you may have to pay them if net tax owing exceeds $3,000 for the year in question and either of the two prior years — $1,800 in Quebec. Farmers and fishers have a single due date of 31 December. Paying tax instalments early is not a loan prepayment and carries no penalty.

Switching lenders or refinancing early

If the goal in breaking a term is to move to a cheaper lender, factor in more than the penalty:

• Requalification: a federally regulated lender must assess you under OSFI Guideline B-20, qualifying you at the greater of your contract rate plus 2 percentage points or 5.25%. Someone who qualified comfortably before may not requalify now.
• Equity position: minimum down payment is 5% on the portion up to $500,000, 10% on the portion from $500,000 to $1,500,000, and 20% above $1,500,000. Under 20% requires mortgage default insurance, and insured mortgages are limited to a 25-year maximum amortisation.
• Fees beyond the penalty: discharge, registration and appraisal costs, plus legal fees where a new mortgage is registered.
• Timing: if renewal is close, waiting may cost less than breaking the term.

Ask the current lender for a written payout statement that separates the penalty from fees. Under PIPEDA you may access the personal information an organisation holds about you, and prepayment terms form part of your agreement.

A practical checklist before you prepay

1. Read the prepayment clause and confirm whether the loan is open or closed.
2. Identify the calculation method: three months' interest, IRD, or the greater of the two.
3. Confirm the privilege limit, its reset date and whether unused room carries over.
4. Request a written payout statement with the penalty broken out from fees.
5. Compare the penalty against the interest you would save by repaying early.
6. Ask whether splitting a lump sum across two privilege years reduces the charge.
7. Check whether you would requalify for replacement financing before committing.

Private loans and promissory notes

Private arrangements often use a promissory note — a written, signed, unconditional promise to pay a sum certain in money under the Bills of Exchange Act. A note may say nothing about early repayment, leaving the parties to agree later. If you intend to allow prepayment, or to charge for it, put the term in the document; silence favours neither side.

Lenders also report borrowing history to Equifax Canada and TransUnion Canada. A hard inquiry from a new application may affect your credit score, while a soft inquiry — such as checking your own report — does not.