How prepayment penalties work
Variable-rate mortgages almost always charge three months' interest at your contract rate — simple and relatively predictable. Fixed-rate mortgages typically charge the greater of three months' interest and the interest rate differential (IRD): your balance times the gap between your contract rate and the rate the lender could re-lend at today, times the years left in your term.
Why bank IRD penalties surprise clients
The trap is in which comparison rate the lender uses. Most big banks compare against their posted rate for your remaining term, minus the discount you originally received — which inflates the rate gap and therefore the penalty. Many monoline lenders compare against actual market rates instead, which is why the same mortgage can carry a penalty several times larger at a big bank than at a monoline. This calculator lets you set the comparison rate yourself so you can model either method.
When paying the penalty is still worth it
A penalty isn't automatically a deal-breaker: if today's rates are far enough below the client's contract rate, the interest savings over the remaining term can outweigh it — especially when the penalty can be capitalized into the new mortgage. Model the new payment with our mortgage payment calculator, and always have the client request a written payout statement from the lender — only that number is binding.