5-Year Commitment and Mortgage Repayment Right in Canada

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In Canada, the Interest Act (a fédéral statute) grants borrowers a fundamental right: the ability to repay a residential mortgage loan after five years, even if the loan term is longer, subject to a maximum penalty of three months' interest. This provision (section 10) applies to fixed-rate loans with terms exceeding five years. It protects borrowers who choose 7, 10 or even 25-year terms by capping the exit penalty after the fifth year. The interest rate differential (IRD), which can be much more costly than three months' interest, therefore does not apply after five years for these longer terms. This protection is particularly relevant in a fluctuating rate environment, where borrowers may want to refinance to take advantage of better rates. Mortgage brokers must inform their clients of this right, especially when recommending terms exceeding five years.

The Interest Act and the Right to Repay

The Interest Act is a Canadian fédéral statute that establishes fundamental rules on interest rates and loan repayment. Its section 10 is particularly important for mortgage borrowers: it grants them the right to repay a residential mortgage loan after five years of a longer fixed term, subject to a penalty capped at three months' interest.

Practical Application

This right applies automatically to fixed-rate loans with an initial term exceeding five years. For example, a borrower who takes out a 10-year fixed-rate loan can repay it in full after five years by paying only three months' interest as a penalty. Without this protection, the lender could demand the interest rate differential (IRD) for the remaining five years, which could amount to tens of thousands of dollars.

Impact on Term Selection

This protection makes longer terms (7, 10 years) more attractive for borrowers seeking payment stability while retaining exit flexibility after five years. The mortgage broker must present this option in their comparative analysis and explain that the maximum penalty of three months' interest applies after the fifth year, even if the rate offered for a longer term is sometimes slightly higher than a five-year term.

Interest Rate Differential (IRD): Penalty calculated by multiplying the difference between the contractual rate and the lender's current rate by the remaining balance and the number of months remaining in the term. This penalty no longer applies after 5 years of a fixed term exceeding 5 years under the Interest Act.

Important Nuances

This right applies to residential fixed-rate loans with terms exceeding five years. It does not apply to variable-rate loans (where the penalty is generally three months' interest at all times), commercial loans or movable hypothecs. The broker must also distinguish between the loan term and the amortization period — it is the term (duration of the current contract) that determines the application of this rule.

Frequently Asked Questions

What is the right to repay after 5 years?

Section 10 of the Interest Act (fédéral statute) allows any residential mortgage borrower to repay their loan after 5 years of a longer term, subject to a maximum penalty of 3 months' interest. This right applies automatically to fixed-rate loans with terms exceeding 5 years, regardless of contract clauses.

Does this right apply to variable-rate loans?

No, this specific Interest Act right applies to fixed-rate loans with terms exceeding 5 years. For variable-rate loans, the penalty is generally 3 months' interest regardless of when repayment occurs, as the IRD typically does not apply to variable rates.

Why is this provision important for longer terms?

Without this protection, a borrower with a 10-year fixed-rate term could face a very high IRD if they wanted to repay in the first few years. After 5 years, the penalty is capped at 3 months' interest, making longer terms more attractive and less risky for borrowers.

Can a lender impose a penalty higher than 3 months' interest after 5 years?

No. The Interest Act is of public order; no contractual clause can override this protection. After 5 years of a fixed term exceeding 5 years, the maximum penalty is 3 months' interest, regardless of what the mortgage contract provides.