The question specifically directs that the penalty be calculated using the three-month interest formula. The calculation is:

Outstanding mortgage balance × annual interest rate × 3/12

Therefore:

$250,000 × 5% × 3/12 = $3,125

The correct answer is option C.

Closed mortgages generally restrict the amount of principal that can be prepaid without charge. When the permitted prepayment privilege is exceeded, a prepayment penalty may apply. The Financial Consumer Agency of Canada explains that mortgage prepayment penalties are commonly calculated using either three months' interest or an interest rate differential, depending on the mortgage terms and lender's methodology.

The 36 months remaining in Fatima's term would be relevant if an interest-rate-differential calculation were required, but it does not alter the three-month interest calculation specified in the question.

The annual interest on the outstanding balance is:

$250,000 × 5% = $12,500

Three months represent one-quarter of a year:

$12,500 ÷ 4 = $3,125

Accordingly, the applicable penalty is $3,125.

FPII reference/topic: Savings Planning and Debt Management — mortgages; closed mortgages; prepayment privileges and penalties.

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