An Alberta borrower is considering breaking their 5-year fixed mortgage in year 3 to refinance at a lower rate. How is the prepayment penalty typically calculated for a fixed-rate mortgage?
Correct Answer
B) The greater of three months' interest or the interest rate differential on the remaining balance and term
For fixed-rate mortgages in Canada, including Alberta, the prepayment penalty is typically the greater of three months' interest or the interest rate differential (IRD). The IRD represents the difference between the original rate and the current rate for the remaining term, applied to the outstanding balance. This penalty can be substantial when rates have dropped significantly.
Why This Is the Correct Answer
Option B correctly states the standard penalty formula: the greater of three months' interest or the IRD. Under Canadian federal lending regulations, fixed-rate mortgage lenders typically use this dual-calculation method. The IRD reflects the lender's lost revenue based on the rate spread over the remaining term, applied to the outstanding balance.
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