Refinance vs Renewal: What Is the Difference?
The terms are often confused, but they describe two distinct actions:
Renewal
When your current mortgage term ends (for example, after 5 years), you renew at a new rate for a new term. There is no penalty because the term has expired. You can renew with your existing lender or switch to a new one.
Refinance (breaking your mortgage)
Ending your mortgage before the term expires and replacing it with a new mortgage — either with the same lender or a different one. This triggers a prepayment penalty because you are breaking the contract early.
Understanding Prepayment Penalties
The prepayment penalty is the single most important number in the refinance decision. It determines whether breaking your mortgage early makes financial sense. The penalty calculation differs between fixed and variable mortgages:
Variable-rate penalty: 3 months of interest
Variable-rate mortgages almost always carry a penalty of 3 months of interest on the remaining balance. On a $400,000 balance at 4.00%, that is approximately $4,000. This makes variable mortgages relatively inexpensive to break.
Fixed-rate penalty: the greater of 3 months of interest or the IRD
Fixed-rate mortgages use the higher of two calculations: 3 months of interest or the Interest Rate Differential (IRD). The IRD compensates the lender for the difference between your contracted rate and their current rate for the remaining term. The IRD penalty can be significantly larger — often $10,000 to $30,000 or more.
The IRD trap
IRD penalties are calculated differently by every lender, and some methods produce penalties that are double or triple what others charge. The Big Five banks are notorious for using their posted rates (not discounted rates) in the IRD calculation, which inflates the penalty significantly. Monoline lenders and credit unions tend to use more borrower-friendly calculations.
Use our penalty calculator to estimate your prepayment penalty based on your specific mortgage details.
The Break-Even Calculation
The core question is simple: do the savings from a lower rate over the remaining term exceed the cost of the penalty? Here is how to run the numbers:
- 1
Calculate your penalty
Call your lender and ask for your exact prepayment penalty. Do not estimate — get the real number. Penalties can vary significantly depending on when during your term you break.
- 2
Determine your monthly savings
Compare your current monthly payment to what it would be at the new lower rate, keeping the same remaining amortization. The difference is your monthly savings.
- 3
Calculate the payback period
Divide the penalty by the monthly savings. If your penalty is $8,000 and you save $300 per month, the payback period is approximately 27 months. If the remaining time on your current term exceeds 27 months, breaking the mortgage makes financial sense.
- 4
Factor in additional costs
Include legal fees for the new mortgage (typically $500 to $1,500), any appraisal costs, and discharge fees from your current lender. These add to the total cost that must be recovered through savings.
Real-World Example
Should You Break? A Scenario
$500,000 balance, 3 years remaining on a 5-year fixed at 5.50%
| Item | Amount |
|---|---|
| Current monthly payment (5.50%) | $3,041 |
| New monthly payment (3.94%) | $2,617 |
| Monthly savings | $424 |
| Prepayment penalty (IRD) | ~$12,000 |
| Legal & discharge fees | ~$1,200 |
| Total cost to break | ~$13,200 |
| Payback period | ~31 months |
| Time remaining in term | 36 months |
| Net savings over remaining term | ~$2,064 |
In this scenario, breaking the mortgage produces a net savings of approximately $2,064 over the remaining 36 months. The savings are modest but positive. If the borrower had only 24 months remaining instead of 36, the payback period would exceed the remaining term — making it a losing proposition.
When Waiting for Renewal Makes More Sense
- Your remaining term is shorter than the payback period — the penalty cannot be recovered before renewal.
- You have a variable-rate mortgage — variable rates have already dropped significantly and the 3-month interest penalty is usually manageable, but the savings from further drops may be small.
- Your penalty is IRD-based and unusually large — some Big Five banks calculate IRD penalties that make breaking prohibitively expensive.
- You are within 6 to 12 months of renewal — at this point, the savings from a lower rate are limited and may not justify the costs.
- Your life circumstances may change — if you might sell the property or make a major move, breaking and refinancing adds unnecessary complexity.
Key Takeaways
- Renewal happens naturally at term end with no penalty. Refinancing means breaking your mortgage early and paying a penalty.
- Variable-rate penalties are typically 3 months of interest — modest and predictable.
- Fixed-rate penalties use the IRD calculation and can be significantly larger, especially at Big Five banks.
- The break-even analysis is straightforward: penalty plus costs divided by monthly savings equals the payback period.
- If the payback period is shorter than your remaining term, breaking makes financial sense.
- Always get the exact penalty amount from your lender — estimates can be off by thousands.
Run the Numbers on Your Mortgage
Use our penalty calculator to find out exactly what it would cost to break your mortgage, then compare that against the savings from today's lower rates.
Free to use. No obligation. No credit check required.