Let’s say a homeowner receives a $500,000 closed mortgage to purchase a home. The loan has a term of 5 years with a fixed interest rate of 5%. In this example, the closed mortgage states that any prepayment above a 10% lump sum each year will incur a penalty.
After owning the home for a year, the owner gets a significant inheritance and decides to put these funds towards their mortgage principal. But, since the lump sum they want to make is 13% of their mortgage principal, it is above the 10% limit and would be subject to a prepayment penalty. A year later, they get a job offer in another province and sell the home, breaking their mortgage early. Since they have a closed mortgage, they will be charged a penalty for breaking the mortgage within the 5 year term.