While you may not have planned on it when you bought your property, for whatever reason you may have to break your mortgage.  Maybe you’re moving out of the country, or you just got a windfall of cash and want to pay off your mortgage completely.

Either way, you’re cancelling your mortgage by paying back your debt faster than the bank wants you to (thus costing them interest), and there is a charge for doing that.

Banks use two separate formulas, and you’ll be on the hook for whichever one costs you more (go figure).

TD has a pretty clear description on their site, which you can see here (click ‘How are prepayment charges calculated?).

Option 1: Three Months’ Interest

Calculated based on the amount you’re pre-paying and your current mortgage rate.  While your bank may use a slightly different formula, TD calculates it like this:

  1. Amount you’re prepaying (ex. $200,000)
  2. Current interest rate (ex. 5% = 0.05)
  3. Multiply together ($200,000 x 0.05) = $10,000
  4. Divide by 4 ($10,000/4 = $2,500)

In this case your cancellation penalty would be $2,500.  As another example, on a $500,000 balance with a 5% rate your penalty would be $6,250.

Option 2: Interest Rate Differential

This one’s a bit more complicated.  The differential is the difference between your current interest rate and the current interest rate for a similar mortgage on the day you cancel.

Here’s how TD calculates it (we’ll use the same numbers as above for a direct comparison).

  1. Your current interest rate (0.05)
  2. Current interest rate that your bank offers for a similar mortgage (ex. 0.03)
  3. Your rate minus the current rate (0.05-0.03=0.02)
  4. Amount you’re prepaying ($200,000)
  5. Number of months remaining on your mortgage term (ex. 2 years = 24 months)
  6. (Interest rate difference (0.02) x Amount you’re repaying ($200,000) x months remaining (24)) / 12.  That’s: (0.02 x 200,000 x 24) / 12 = $8,000

We now take the greater of the two amounts.  Option 1 was $6,250 and Option 2 is $8,000, so you’d estimate your pre-payment penalty to be $8,000.

In our second example, Option 1 is $6,250 and Option 2 comes out to a whopping $20,000, so that’s what you’d be on the hook for.

Steps To Lower Your Cancellation Cost

Looking at these formulas, it’s obviously in your best interest to have fewer months left on your mortgage term and a lower balance that you’re paying back.

So the longer you wait before cancelling, the better.  In our second example, even waiting an extra 2 months reduces your cancellation penalty to $18,333 ((0.02 x 500,000 x 22)/12).

The other option is to pay down as much of your mortgage as you can before cancelling.  Depending on your mortgage policy, you’re probably allowed a certain amount of additional payments you can make without penalty.  If, for example, you can come up with $30,000 before cancelling your mortgage, you can reduce our second example to $18,800 ((0.02 x 470.000 x 24) / 12).

If you can both wait two months and pay an extra 30K ahead of time, you can save even more, paying $17,233 ((0.02 x 470.000 x 22) / 12).

As always, check with your specific mortgage terms and your bank’s policy to understand your prepayment options and the way they calculate a cancellation penalty.