Definition
The three months interest penalty is the formula applied almost universally when you break a variable-rate mortgage before the end of the term. It is calculated as: outstanding balance × contractual rate × 3 ÷ 12.
Example: on a CA$350,000 balance at a 5.75% contractual rate, the penalty would be 350,000 × 5.75% × 0.25 = approximately CA$5,031. The formula is known upfront and easy to model, unlike IRD which depends on reference rates at the time of breakage.
This is the main reason a variable rate offers greater exit flexibility than a fixed rate: refinancing, selling, or breaking due to separation triggers a predictable, bounded penalty. Some lenders also apply 3 months interest on short fixed terms (≤ 2 years) — check your contract.