Selling in Ottawa: why the 5-year mortgage rule rarely helps

The rule sellers quote, and the one phrase it hinges on

Every few weeks a seller tells me they can break their mortgage for three months of interest because "it's been five years." Sometimes that is true. Most of the time it is not.

Section 10 of the federal Interest Act covers mortgages on real property that are not payable until more than five years after their date. On those, once five years have passed, the borrower can pay the mortgage off by adding three months of further interest. That is the whole benefit. The hinge is "more than five years." It is about the length of your term. It is not about your amortization, and it is not about how long you have owned the house.

A standard five-year fixed is payable in five years, not more than five. It does not qualify. A seven or ten year term does. The section also does not apply to a mortgage given by a corporation, so an investor holding a rental in a numbered company does not get it either. I read the statute on the Justice Laws site, and the link is at the bottom of this post. If your term is unusual, a real estate lawyer can tell you in ten minutes.

What most Ottawa sellers actually face

For the typical five-year mortgage, the penalty comes from your contract, not the statute. The general pattern across Canadian lenders is that a variable rate mortgage costs about three months of interest to break, a fixed rate mortgage costs the greater of three months of interest or an interest rate differential (IRD), and an open mortgage costs nothing. Your contract sets the exact method, and lenders calculate IRD differently.

Run the three month version on the example from my post on 2021 mortgage renewals. A $412,000 balance at 1.99% is $412,000 times 0.0199 divided by 4, which is about $2,050.

Now the IRD version, and this one is a made up case to show the mechanics, not a quote. Say the lender decides the gap between your rate and its comparison rate is 1.00 point, and you have 2 years left. That is $412,000 times 0.01 times 2, or $8,240. Change the gap to 2 points and it doubles. Real IRD formulas use the lender's own posted rates and often strip out the discount you were given, so the real number can be well above a simple version. I cannot calculate yours from here, and a mortgage calculator on a website cannot either.

My renewals post put commission and legal costs above $28,000 on a $632,000 sale. A penalty comes on top of that. It is a known, one time cost, and it is usually smaller than people fear until a fixed rate IRD enters the picture.

Three ways to shrink it

First, look at the maturity date before you look at listing dates. A mortgage is open for prepayment at maturity. If yours matures February 1 and you sign an offer in December, a closing on or after February 1 can take the penalty to zero. Most buyers want 30 to 60 days, but many will give you more if you ask early and the price is right. My seller checklist on firm to close covers what happens between the firm date and the keys.

Second, if you are buying another home, ask about porting. Many lenders let you carry your rate and remaining term to the next property. Expect to requalify, and expect the lender to set a window between your sale closing and your purchase closing. If the two closings are far apart, porting can fail, and then the penalty is back. If you are selling and buying, read my post on what happens when a buyer has to sell first, because the same timing problem works on the other side of your deal.

Third, do not price the house to cover the penalty. A buyer does not care what your lender charges you. If the penalty is $8,000 and the market says your house is worth $8,000 less than your hopeful number, the house will sit, and a listing that sits costs more than the penalty did. I see this about once a month.

What to do this week

Pull your mortgage documents and find five things: the lender, whether the rate is fixed or variable, the term length, the maturity date, and whether the mortgage is open or closed. Then phone the lender and ask for a written penalty quote for the closing date you have in mind. Ask them to state the method. Ask whether you can port. If your term is longer than five years, ask specifically about section 10 and when the five years run out.

I sell houses. I do not sell mortgages, and none of this is mortgage, legal or tax advice. Your lender, a mortgage broker, or a lawyer can tell you what your contract says.

Once you have the maturity date and a penalty quote, send them to me. Timing a listing around a mortgage maturity is a real strategy, and sometimes waiting six weeks is worth more than listing this week. Sometimes it is not, and I will say so. Call me at 613-262-6545 or email fil@613realtor.ca with your maturity date and I will tell you which one it is.

Sources: Interest Act, section 10, Justice Laws. Penalty patterns from Milesopedia on mandatory mortgage penalties.