IRD or three months' interest: the formula a client doesn't choose.

Most variable-rate mortgages only ever face the three-month interest penalty. Fixed-rate mortgages are typically charged the higher of the IRD or three months' interest — which in practice usually means the IRD applies whenever the client's contract rate is higher than the lender's current rate for a comparable remaining term, and the client signed less than five years ago.

The reverse case matters too: if the lender's current rate for the remaining term is actually higher than the client's contract rate — which can happen if rates have risen since the client signed — the IRD calculation produces a negative or zero result, and the lender simply falls back to charging three months' interest instead. A client breaking a fixed mortgage in a rising-rate environment is far less likely to face a large IRD than one breaking a fixed mortgage after rates have fallen.

Take the outstanding mortgage balance, multiply it by the current annual interest rate, divide by 12 to get a monthly figure, then multiply by three. It's a fixed, predictable formula that doesn't depend on where rates have moved since the client signed.

On a $400,000 balance at 5%, that's $400,000 × 0.05 ÷ 12 × 3 — $5,000. Because the inputs are just the current balance and the current rate, a broker or client can estimate this penalty accurately without needing the lender's posted-rate schedule at all, which is exactly why it's the simpler and more predictable of the two formulas to explain up front.

1. 01Outstanding balance × annual interest rate
2. 02Divide the result by 12 (one month's interest)
3. 03Multiply by 3 for the three-month penalty

The IRD compares the client's contract rate to the lender's current posted or discounted rate for a term matching however much time is left on the mortgage, then applies that rate gap to the outstanding balance over the remaining term. If rates have dropped since the client signed, that gap — and the balance it's applied against for potentially years of remaining term — is what drives the penalty far higher than a flat three-month calculation.

This is also why IRD estimates vary so much from lender to lender: each lender uses its own posted-rate schedule and its own comparison-rate methodology, which isn't standardized across the industry the way the three-month formula is.

Some lenders compare against their current posted rate for the remaining term, while others compare against a discounted rate closer to what the client would actually be offered today — the second method typically produces a smaller gap, and therefore a smaller penalty, than the first. A client shopping a mortgage break, or a broker estimating one before recommending a move, should ask the specific lender which methodology applies rather than assuming a generic online calculator reflects that lender's actual formula.

A client comparing a 3-year term to a 5-year term (see short-term vs. five-year fixed) is implicitly also choosing how much runway an IRD penalty would have to compound over if their plans change and they need to break the mortgage early. A shorter term simply has less remaining time for a rate gap to apply against, which caps the potential penalty even before rates move at all.

Life circumstances that change a client's plans mid-term — a job relocation, a growing family needing more space, a separation — are common enough that this isn't a hypothetical worth glossing over. A client who signs a 5-year fixed assuming they'll simply ride it out for five years is making a bet on their own life staying predictable, which is a different (and less certain) bet than the one they're making on interest rates.

Flagging this trade-off during the term conversation — not after a client calls wanting to break a mortgage — is part of what keeps a broker's advice ahead of the surprise rather than explaining it after the fact.