The only comparison that matters
When you break a mortgage early, two things happen. You pay a penalty and some switching costs today. In exchange, you pay less interest every month from now on. The break-even point is the month when the interest you've saved finally adds up to what you paid to leave.
The deadline is your current maturity date. Once your term ends, you could switch to the lower rate anyway with no penalty. So a refinance only makes sense if you break even before that date. Savings after it don't count, because you'd have had them either way.
Worked example: the same rate drop, two very different answers
You owe $350,000 at 5.79% fixed with 30 months left in your term and 22 years left on your amortization. A new lender offers 4.29%. Switching costs $1,500.
| Fixed, IRD penalty | Variable, 3 months' interest | |
|---|---|---|
| Penalty | $13,125 | $5,066 |
| Total cost to break | $14,625 | $6,566 |
| Interest saved over 30 months | $12,693 | $12,693 |
| Net result | −$1,932 | +$6,127 |
| Break-even | Month 35 (too late) | Month 16 |
The monthly payment drops by about $290 either way. But with the interest rate differential penalty, the savings don't catch up until month 35, five months after the term would have ended on its own. Breaking would cost you money. With a three-month-interest penalty, the same move puts more than $6,000 in your pocket.
How the two penalties work
Three months' interest is simple: your balance × your rate × 3/12. On $350,000 at 5.79%, that's $5,066. Variable-rate mortgages almost always use only this method.
The interest rate differential (IRD) applies to most fixed-rate mortgages, and you pay whichever is greater. It aims to compensate the lender for the interest it loses by re-lending your money at today's lower rate. In its simplest form:
IRD = balance × (your rate − comparison rate) × months remaining ÷ 12
On our example, that's $350,000 × 1.50% × 30 ÷ 12 = $13,125.
The comparison rate is where lenders differ. Many big banks use their posted rates and subtract the discount you received when you signed. That can make the comparison rate much lower and the penalty much bigger than this calculator estimates. Monoline lenders, who lend only through brokers, often use a fairer method. Our guide to mortgage penalties and IRD walks through both methods with numbers.
Get the real penalty in writing before you decide. Call your lender, ask for a payout or penalty statement as of a specific date, and ask which comparison rate they used. Federally regulated lenders have to explain how your penalty is calculated, and most offer an online penalty calculator.
Ways to lower the penalty
- Use your prepayment privileges first. If your mortgage allows a 15% or 20% lump sum each year, making it before you break reduces the balance the penalty is calculated on. Some lenders apply this automatically. Ask.
- Wait. Every month that passes reduces the months remaining, which reduces the IRD. Run the calculator with fewer months left to see how quickly it falls.
- Blend and extend. Some lenders will blend your old rate with today's rate and extend your term. There's no upfront penalty, but part of its cost is built into the blended rate, so you won't get the full new rate. Compare it with the numbers above.
- Port your mortgage. If you're selling and buying, porting the mortgage to the new home can avoid the penalty entirely.
What this calculator assumes
It keeps your remaining amortization the same at both rates, so you can compare like with like. It assumes you pay the penalty and costs out of pocket. If you add them to the new mortgage instead, you'll pay interest on them too, which pushes the break-even point later. And it doesn't account for the new rate changing after your current term would have ended, since by then the decision no longer depends on breaking early.