How IRD Penalties Really Work: Posted-Rate vs. Market-Rate Methods Compared

The IRD formula itself

For fixed-rate mortgages, lenders typically charge the greater of three months' interest and the interest rate differential:

IRD = balance × (contract rate − comparison rate) × years remaining in term

The balance, contract rate, and remaining term are facts. The comparison rate is a policy choice — and it's where the methods diverge.

Method 1: The posted-rate method (most big banks)

Big banks typically take their current posted rate for a term matching the time remaining, then subtract the discount the client originally received off posted. Because posted rates run well above street rates and original discounts are often 1.5–2 points, this manufactures a wide rate gap — and a large penalty.

Worked example. Client has a $385,000 balance at 5.40% fixed with 32 months left. At origination the posted rate was 6.90%, so their discount was 1.50 points. The bank's posted rate for a ~3-year term today is 5.90%:

• Comparison rate = 5.90% − 1.50% = 4.40%
• Rate differential = 5.40% − 4.40% = 1.00 point
• IRD = $385,000 × 1.00% × (32 ÷ 12) ≈ $10,267
• Three months' interest = $385,000 × 5.40% ÷ 12 × 3 ≈ $5,198

The bank charges the greater number: ≈$10,267.

Method 2: The market-rate method (many monolines)

Many monoline lenders compare against the rate they actually re-lend at for the remaining term — no posted-rate inflation, no reapplied discount. Same client, same balance, but the comparison rate is today's market rate of, say, 5.00%:

• Rate differential = 5.40% − 5.00% = 0.40 points
• IRD = $385,000 × 0.40% × (32 ÷ 12) ≈ $4,107
• Three months' interest ≈ $5,198 — now the larger number, so it applies

Identical mortgage, ≈$5,198 vs. ≈$10,267 — nearly double, purely from the comparison-rate convention. (Run your own scenarios in our prepayment penalty calculator, which lets you set the comparison rate directly so you can model either method.)

What this means at origination

• The penalty clause is a pricing feature. A monoline at the same rate as a big bank is not the same product — quantify the difference for clients likely to move, refinance, or break early.
• Record the posted rate and discount at funding. You cannot estimate a future big-bank IRD without the original discount; capture it in the file while it's easy.
• Watch the term clock. IRD scales with remaining term, so the same break costs less every month. Sometimes waiting two or three months — or porting — changes the recommendation entirely.
• Only a written payout statement is binding. Reinvestment-rate wording, rounding of the remaining term, and per-lender quirks mean every estimate (including this one) is directional. Have the client request the statement before you finalize advice.

Related reading

Penalty math usually shows up mid-refinance, next to qualification math — see our guide to GDS/TDS ratios and the stress test and the Canadian mortgage payment calculator. Inside BrokerOS, the penalty tool models lender-specific conventions against live client files.