IRD
Interest Rate Differential
Interest Rate Differential: a prepayment penalty on closed fixed-rate mortgages that approximates the interest the lender loses when you break early. It's roughly your balance × (your rate − a comparison rate for the time left in your term) × the years remaining. On a fixed mortgage you usually pay the greater of the IRD or three months' interest.
IRD compensates the lender when you break a fixed mortgage early and its current rates are lower than yours. The bigger the gap between your rate and the comparison rate, and the more time left on your term, the larger the penalty. When current rates are above your rate, the IRD is typically zero and three months' interest applies.
The comparison rate is where lenders differ. Many large banks use the posted-rate method: they take their current posted rate for a term close to your remaining term and subtract the discount you received off the posted rate when you signed. Subtracting that original discount produces a lower comparison rate, which means a bigger gap and a bigger penalty.
Many monoline lenders use a contract-rate method instead, comparing your rate with the actual rate they offer today for your remaining term. With no discount subtracted, the gap and the penalty are usually smaller. Exact formulas (including any present-value discounting) are set out in your mortgage contract.
Before you break, refinance, or sell, get your exact penalty in writing. Porting to a new home, a blend-and-extend, using your prepayment privilege first, or waiting until closer to maturity can cost far less than paying the IRD outright.
Worked example
Illustrative, simplified: $400,000 balance at 4.00% with 30 months (2.5 years) left. You got a 1.50% discount off a 5.50% posted rate when you signed. The lender's posted rate for the closest term today is 5.00%.
Posted-rate method: comparison rate = 5.00% − 1.50% = 3.50%. IRD = $400,000 × (4.00% − 3.50%) × 2.5 = $5,000. Three months' interest = $400,000 × 4.00% ÷ 4 = $4,000, so the penalty is $5,000 (the greater amount).
Contract-rate method: if the lender's actual rate for the remaining term is 3.90%, IRD = $400,000 × 0.10% × 2.5 = $1,000, so the penalty would be three months' interest, $4,000.
Illustrative figures only, rounded; not a quote or current rate. See today’s rates on our live board.
Sources
- Mortgage fees: Prepayment penalties (Financial Consumer Agency of Canada)
- Breaking your mortgage contract (Financial Consumer Agency of Canada)
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