What's more important, a low rate or a low penalty?

June 16, 2020 | Posted by: Mike Garganis

Mortgage rates have been falling almost weekly since the beginning of April. We’ve gotten to a point where bank-offered fixed and variable rates are both under 2% for the first time in Canadian history.

HSBC slashed its 5-year fixed rate to 1.99% for default-insured mortgages. That broke the record for a bank-advertised 5-year fixed rate.

Who is this for:  First-Time Home Buyers or anyone putting less than 20%. Not eligible for refinance or renewal, purchases only.

Disclaimer:  They aren't factoring in the true APR (Annual Percentage Rate) when you add the default insurance to the balance you are borrowing, not to mention HSBC fees.  

Disclaimer 2: HSBC has a big-bank-style penalty — i.e., That penalty can apply if you break this mortgage early, depending on where rates are at the time. Keep that in mind if there’s any chance whatsoever that you’ll sell or refinance before 2025.

There are now multiple lenders offering insured fixed and variable rates in the “1s', you have options that make a lot more sense.

Fixed or Variable…Which Keeps More in Your Pocket?

It’s perhaps the most common mortgage question after, “what’s the best rate?” And it’s a question that’s more relevant than ever.

With the Bank of Canada hinting that interest rates will stay lower for multiple quarters, yet not drop further (in terms of its key lending rate), the decision between fixed or variable seems perplexing.

It doesn’t help that the difference between the best 5-year fixed and variable rates is so narrow, relative to “normal.”  We’re talking just a quarter-point between them, half the 10-year average.

To add some clarity, here’s a simple hypothetical comparing both terms.

Bank of Canada will hike its key lending rate three times over the next five years—which is what it did following the financial crisis of 2008-09.

If it did, that would take today’s lowest nationally available variable rate of 1.75% to 2.50% within the first 18 months of the term. 

THE MAJOR DIFFERENCE BETWEEN A FIXED MORTGAGE RATE AND VARIABLE RATE - variable-rate mortgages entail a maximum three months’ interest charge for early termination, whereas fixed rates can sting you with costly interest rate differential (IRD) penalties.  On average a variable rate mortgage is roughly $4,000 compared to $20,000.

A recent article outlining how TD Bank charged a $30,000 mortgage penalty to a woman forced to sell her home due to the Covid-19 pandemic shows how this remains relevant today.


  • The most popular mortgage product is a 5-year fixed
  • The most profitable is a 5-year fixed
  • On average, a mortgage is refinanced or someone moves every 3 years
  • Mortgage penalties affect more people than you think!


“The IRD amount is calculated on the amount being prepaid using an interest rate equal to the difference between your existing mortgage interest rate and the interest rate that we can now charge when re-lending the funds for the remaining term of the mortgage.”

Did anybody get that? The IRD penalty is there to compensate the bank for any loss due to a mortgage being paid out and then to have to lend funds out again for the remaining term at a rate that’s less than what they had in the contract. I don’t think anyone would have a problem with that. After all, it’s a business and they can’t be expected to take a loss.

But somewhere along the line, this reasoning got lost or forgotten. The current IRD penalty calculation is OVER-CHARGING borrowers. And the banks have shrunk their spread between posted and discounted rates on shorter-term mortgages, causing borrowers to pay record mortgage penalties in the $10k, $15k and $20k range and higher!


Let’s look at the numbers. Let’s use a $200,000 mortgage that was taken out in December 2008 at 5.54% for a 5-year fixed term. The Posted rate was 6.95%, giving us a discount of 1.41% off the 5-year fixed rate. In January 2011, the 3-year posted rate was 4.15%. (We’re using TD Canada Trust in this example because they have a clear explanation and formula on prepayment penalties on their website… but this formula is similar to what the other Big Six banks are using.)

Using the IRD formula from their website, the penalty would be approximately $16,800. That’s equal to 18 months of interest!! Here’s what’s happening… The banks are using your original discount given at the time of the mortgage. They take that discount, in this case, 1.41%, and subtract that from their posted 3-year fixed rate (4.15% – 1.41% = 2.74%). The problem is that NONE of the Big Six Banks are advertising a 1.41% discount off their 3-year rate… The best advertised rate that we could find with TD Canada Trust is through their broker channel. That rate is 3.60%. So why are they using 2.74% to calculate your IRD penalty?

What’s even more disturbing is that this formula has gone unchecked by governments, regulators and watchdogs for almost a decade. Wait, it gets worse… we all know that mortgage rates have been at record lows for the past 18 months. This alone would cost borrowers even more to get out of their mortgage. The banks don’t seem content with that… They have shrunk their spread on shorter-term mortgages, making these penalties higher than ever.

In 2007, TD had a posted 3-year fixed rate of 7.35% and a discounted rate of 6.05%… that’s a 1.30% discount. But in January 2011, the posted 3-year rate was 4.15% and the discounted rate was 3.60%… a discount of just 0.55%.

That reduced posted rate is costing borrowers dearly. And, to put this in a better context, if the posted 3-year fixed rate was 1.30% higher than the discounted rate, then the penalty would be approximately $11,640 instead of $16,800. (As an aside, if this was 1998, your penalty would cost $8,340 because the bank only used the Posted rate when calculating the penalty.)


We need to get more attention on this subject. These penalties are unfair, unjust and the logic isn’t adding up to the original reason for having mortgage penalties to begin with.

Are you still going to ask me for the lowest rate?

Have a great day!

Mike Garganis

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