Selling a Property With an Existing Mortgage in Canada
Across Canada, it is entirely common to sell a property before the mortgage term has expired. This situation arises during job relocations, family changes, separations, or simply a shift in life plans. However, breaking a mortgage contract before the end of the term carries financial consequences that are essential to understand and plan for.
Understanding the Prepayment Penalty
The prepayment penalty is the cost imposed by the lender when you repay your mortgage before the term's maturity. The calculation method varies by rate type. For a variable-rate mortgage, the penalty is typically three months' interest on the remaining balance. For a fixed-rate mortgage, the calculation is more complex: the lender applies the greater of three months' interest or the interest rate differential (IRD).
The IRD is calculated by multiplying the difference between your contract rate and the lender's current rate for a term equivalent to your remaining duration, by the outstanding balance, then by the number of months remaining. For example, if your rate is 5.00%, the current rate for a term matching your remaining duration is 3.50%, and you have 36 months left, the IRD will be significantly higher than three months' interest. IRD penalties can reach substantial amounts, sometimes exceeding $20,000 on a $400,000 balance.
Mortgage Portability: An Option to Avoid the Penalty
Mortgage portability allows you to transfer the conditions of your current loan (rate, remaining term, balance) to a new property. If you are selling and buying simultaneously, this option can save you the entire penalty. Most major Canadian financial institutions, including the Big Six banks and Desjardins, offer portability on their conventional mortgage products.
To use portability, several conditions must be met. The purchase of the new property must generally close within 30 to 120 days of the sale. It is necessary to re-qualify under the lender's criteria and OSFI guidelines (B-20 stress test). If the new loan is for a higher amount, the additional portion will be at the current rate, creating a blended mortgage with two portions at different rates.
Other Options to Consider When Selling
- Wait for term expiry: if maturity is only a few months away, it may be financially advantageous to delay the sale to avoid the penalty. The last 90 days before maturity typically allow penalty-free repayment.
- Use prepayment privileges: most mortgage contracts allow annual prepayments of 10% to 20% of the original balance without penalty. Maximizing these payments before selling reduces the balance on which the penalty is calculated.
- Assumption by the buyer: in rare cases, the buyer can take over your mortgage under the same conditions. This is uncommon but may be considered if your rate is below current market rates.
- Negotiate with the lender: some lenders may offer a penalty discount if you transfer your mortgage to a new product with them. Always request a written penalty statement before making a decision.
The Role of the Notary and Broker During the Sale
In Quebec, the notary plays a central role in closing real estate transactions. The notary obtains the mortgage payout statement from the lender, deducts the necessary amount for full repayment (including the penalty) from the sale proceeds, and files the mortgage discharge with the Quebec Land Registry. The AMF-certified mortgage broker supports the seller upstream by analyzing available options and minimizing the financial impact of breaking the term.