Prepayment Penalty
A prepayment penalty is a fee charged when you pay off your mortgage early — through refinancing, selling, or making large extra payments. Learn which loans carry them, how they are calculated, and how to avoid them.
Definition
A prepayment penalty is a fee charged by a lender when a borrower pays off the mortgage balance before the agreed term ends — whether by selling, refinancing, or making large extra principal payments. Most US QM loans prohibit them; non-QM and Canadian mortgages commonly include them.
Prepayment penalty by loan type
| Loan type | Prepayment penalty | Notes |
|---|---|---|
| Conventional QM (US) | Not permitted | QM rule prohibits for qualified mortgages |
| FHA / VA / USDA | Not permitted | Government-backed loans — prohibited |
| Non-QM (US) | Up to 2%/1%/0% (yrs 1/2/3) | Soft or hard; varies by lender |
| Fixed-rate (Canada) | Greater of 3-mo interest or IRD | Can be very large — calculate before breaking |
| Variable-rate (Canada) | 3 months' interest | Predictable and usually modest |
| Commercial / CMBS | Yield maintenance or defeasance | Can be equal to remaining interest |
The Canadian IRD penalty — a worked example
The Interest Rate Differential (IRD) is the most significant prepayment cost Canadian homeowners face when breaking a fixed mortgage. Example: you have 3 years remaining on a 5-year fixed at 4.5%, with a $350,000 balance. The bank's current posted 3-year rate is 5.25%.
In a falling-rate environment where the bank's posted rate is lower than your contract rate, the IRD can be far larger. Always request a penalty calculation from your lender before breaking a Canadian mortgage.
Common questions
Are prepayment penalties legal in the US?
Prepayment penalties on most residential mortgages are heavily restricted. Under the CFPB's Qualified Mortgage rule, standard QM loans cannot have prepayment penalties. For non-QM loans, prepayment penalties are allowed but limited: maximum 2% of the outstanding balance in year one, 1% in year two, and 0% after year three. Hard prepayment penalties (covering all payoff scenarios) are no longer permitted on QM loans. Commercial and investment property loans are not subject to the same restrictions.
What is the difference between a hard and soft prepayment penalty?
A hard prepayment penalty applies to all payoffs — whether from selling, refinancing, or extra payments. A soft prepayment penalty applies only to refinancing, not to a sale. If you are selling your home, a soft penalty would not apply. Most modern non-QM loans use soft penalties. Always confirm in your loan documents whether the penalty is hard or soft before signing — and ask specifically about the sale scenario.
What is a yield maintenance clause and where does it appear?
Yield maintenance is a commercial mortgage prepayment penalty designed to compensate the lender for lost interest income. It is calculated as the present value of remaining interest payments, discounted at a Treasury rate. It is common in commercial real estate, multifamily, and CMBS (Commercial Mortgage-Backed Securities) loans. For residential borrowers, yield maintenance is not common — but it can appear in some private lender and non-QM products. If you see "yield maintenance" in a residential loan, that is a red flag requiring careful review.
Do Canadian mortgages have prepayment penalties?
Yes — Canadian fixed-rate mortgages carry significant prepayment penalties. The standard penalty is the greater of: (1) 3 months' interest, or (2) the Interest Rate Differential (IRD) — calculated as the difference between your contract rate and the lender's current posted rate for a term similar to your remaining term, applied to your balance. In a falling-rate environment, the IRD can be substantial — Canadian borrowers breaking fixed-rate mortgages early have faced penalties of $20,000–$40,000+. Variable-rate mortgages in Canada typically carry only a 3-month interest penalty.
How do I check if my mortgage has a prepayment penalty?
For US loans, check: (1) Your Note (the promissory note signed at closing) — Section 5 or 6 typically covers prepayment. (2) Your Loan Estimate and Closing Disclosure — the CFPB requires prepayment penalty disclosure in a dedicated section. (3) Ask your servicer directly for a payoff quote — they must disclose any penalty applied. For Canadian mortgages, contact your lender and request a prepayment penalty calculation before breaking the term.