A homeowner called me recently about renewing roughly $850,000. They opened with the question I hear more than any other: “Should I go fixed or variable?”

A few minutes in, the real question came out. Their child starts school next fall, and there’s a good chance they’ll want to move closer to it. So the question wasn’t really about rates. It was: if I have to get out of this mortgage in a year, what will it cost me?

Most people choose a mortgage on the rate and only learn about the penalty on the way out. The penalty is part of the price you agree to when you sign. It’s what you pay for the flexibility you gave up. So it’s worth understanding before you sign, not after.

The two formulas

On a variable-rate mortgage, the penalty to break is usually three months’ interest. It’s simple and predictable. You can work it out on the back of an envelope.

On a fixed-rate mortgage, the penalty is usually the greater of three months’ interest or the interest rate differential (IRD). The IRD is meant to cover the interest the lender loses when you leave early and they have to re-lend that money at today’s rates.

The words “the greater of” matter. When you’re on a fixed rate, the lender works out both numbers and charges you the bigger one.

Why a fixed-rate IRD can reach five figures

Here’s an illustrative example. Say you locked in at 5.5% a few years ago, you owe $600,000, and you have two years left on your term. The comparison rate the lender uses today works out to about 4.3%.

• Three months’ interest: about $8,250
• IRD: the 1.2% difference, on $600,000, for the two years left, is roughly $14,400

The lender charges the bigger number, so the penalty is about $14,400.

How the lender picks that comparison rate makes a big difference. Many lenders start from their posted rate for a term close to the time you have left, then subtract the discount you got when you signed. If you got a large discount off the posted rate at signing, that same discount comes off the comparison rate, and the gap (and the penalty) can end up larger than the difference between your rate and what you could actually get today. Two lenders can give you very different penalties on the same balance.

This works in both directions. When rates rise after you lock in, the IRD shrinks, sometimes to nothing, and three months’ interest becomes the number that applies. The big penalties show up when rates have fallen since you signed.

Your mortgage documents spell out exactly how your lender calculates it. It’s worth reading that section once.

“I might move” changes the answer

Back to the renewal. On $850,000 at a variable rate around 3.9%, three months’ interest is roughly $8,300. That’s the cost of leaving, and it doesn’t change much however rates move.

On a fixed rate, the answer depends on where rates go between now and the day you leave. If they fall, the IRD can climb well past that.

That doesn’t make variable the automatic answer. Markets are currently pricing the next Bank of Canada move as a hike, not a cut, and a variable rate means living with that risk every month. But if there’s a real chance you’ll sell or refinance in the next year or two, the penalty belongs in the decision right next to the rate. A slightly lower fixed rate can cost you far more than it saves if you break it early.

The honest question to ask yourself is not “which rate is lower?” It’s “how likely am I to leave before the term is up?”

Ways to lower the cost

If you already have a mortgage and a move is coming, you have more options than people think:

• Porting. Many mortgages let you take your rate and balance to a new home. You still have to requalify, the purchase usually has to close within a set window, and if you need more money the extra is blended at today’s rates. When it works, you avoid the penalty entirely.
• Staying with your lender. Some lenders will refund or reduce the penalty if you take a new mortgage with them within a certain window. The rules are specific, so get them in writing before you rely on them.
• Prepayment privileges. Most mortgages let you prepay a percentage of the original balance each year. Using that privilege before you pay out lowers the balance the penalty is calculated on. Check whether your lender allows it right before a payout.
• A shorter term. If a move is likely, a shorter term can line your maturity up with your plans, so you finish the term instead of breaking it.

Life happens

Weddings, kids, job changes, a parent who needs help. None of it follows a five-year schedule. A good mortgage leaves room for that: prepayment privileges you can use when things go well, and access to equity when they don’t.

If a big life change is on the horizon, keep your options open. Clear high-interest card debt before you pour extra money into the mortgage, and think twice before locking in the lowest rate available if it comes with the least flexibility.

Before you sell, refinance or switch

Get your penalty estimate first. It takes one call to your lender (or to me), and it changes the math on almost every decision: selling, refinancing, switching at renewal, or choosing fixed vs. variable in the first place.

If you’d like a second set of eyes on your numbers, I’m happy to walk through them with you.

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