Canadians seeking a sure-fire investment return should look no further than their mortgage. Paying it down as quickly as you can will, in most cases, result in a stellar return on your investment.
Prepayment options are worth exploring because paying down even a small amount of principal (the true cost of the mortgage loan minus the interest) has huge benefits over the life of a mortgage.
Mortgages are front-loaded when it comes to interest meaning, in the early years, most of the money you pay goes toward paying the interest on the amount you borrow as opposed to the principal.
For instance, if you borrow 95% of your home’s value, you’re paying $3 of interest for every $1 of principal you pay. So, by paying an extra $1 of principal, that’s $3 less you’ll have to pay in interest, at least in the early stages of a mortgage.
Range of Prepayment Options
There are a variety of ways to make prepayments work to pay down your mortgage faster. We can discuss your specific needs, but following are some general rules.
Most lenders allow you to make a lump-sum payment of anywhere between 10% and 25% of the value of your mortgage per year. The lump-sum payment is based on either the original amount you borrowed or the amount currently outstanding. Since mortgages decrease with each payment, it’s best to negotiate a lump-sum payment option based on the original amount you borrow. That way, if you come into an inheritance, a big bonus or save a large sum of money, you can pay down the largest amount possible.
Another factor to consider is when you can make a lump-sum payment. Some mortgages allow prepayments during the year, while others permit it only on the anniversary date. Still others allow you to make prepayments on the day you make your regular payment.
If you can’t pay the maximum prepayment amount, it’s still worth your while to at least make some extra payment, even if it’s a few thousand dollars each year. That will still save you thousands of dollars in interest payments.
Another prepayment option involves taking advantage of flexible payments. Most lenders allow you to increase your regular payment up to a set maximum, such as 15%, while others allow you to double up your payments.
If, for instance, you have a $1,000 per month mortgage payment and increase it by 15% to $1,150, you could shave off as much as five-and-a-half years on a $200,000 mortgage.
You can also pay off your mortgage faster by moving to a different payment schedule. Instead of making monthly payments, make them biweekly or even weekly. Using an accelerated mortgage – where you make payments every two weeks as opposed to twice a month – you actually make one extra payment in the calendar year. By paying more and paying faster, you reduce your principal earlier, which lowers the amount of interest you pay.
Another option is to round up your mortgage payment from, say, $766 to an even figure such as $800, because any extra little bit goes toward the principal.
As always, if you have any questions about prepayment options or your mortgage in general, I’m here to help!