Each year, about one-fourth of Canadians who have a mortgage take advantage of mortgage prepayment options. What is a mortgage prepayment? Basically, it is any payment you make on your mortgage in excess of your normal principal and interest payments. Prepayment techniques allow you to pay off your mortgage before the end of the contracted amortization period and save a lot of money. We are the best site online for detailed information on mortgage prepayment options in Canada. Read on so that you will be prepared to pay off your mortgage early no matter the specific mortgage that you finally choose.
Understanding mortgage prepayment in Canada depends first on understanding how pre-paying your mortgage might affect you financially in regards to extra mortgage fees. Because lenders make money on your loan via the interest you pay, a loan that is paid off before the end of its loan term or amortization period represents less money for lenders. Consequently, many lenders will not allow you to pay off your loan in full before the end of your mortgage term without charging you extra fees to make up for the lost income. A loan that cannot be paid off early without incurring extra fees is known as a closed mortgage. Closed mortgages tend to have lower interest rates than open mortgages, which do not charge you extra fees when they are paid off early. The higher interest rate on open mortgages is charged to compensate the bank for risking a loss of interest income through an early mortgage payoff.
It should be noted, however, that while a closed mortgage will not allow you to pay off the loan in full without prepayment penalties, most closed mortgage terms allow you to make some additional payments toward your mortgage principal during your loan term. Many closed mortgages allow you to increase your mortgage payment once a year up to 100 percent without charging you extra fees. Lump sum prepayments are also a possibility for many closed mortgage loans. Under a lump sum prepayment option, you can prepay a lump sum up to a certain percentage of your original loan balance each year without any penalty. Another option that may let you pay off your loan early under open mortgage or closed mortgage terms is what is sometimes called a “money merge” account. With a money merge account, you get a home equity line of credit (HELOC) that you use to pay off your mortgage and fund other expenses. Each month, you deposit your income check into the HELOC, which means that the amount you have left after paying your expenses pays down the credit line. As long as you do not overspend, you get automatic principal reduction over time.
The main reason you should prepay your mortgage has to do with the amount of money you can save and the degree to which you can shorten the length of your loan. Paying just a little bit more toward your loan each month can have a drastic impact on your total interest and loan length because the faster you reduce your principal, the less interest accrues each month. In turn, the amount of your regular payment that goes toward your principal increases. The result is a snowball effect. Extra payments, along with the portion of your normal mortgage payment devoted to loan principal, reduce your principal balance faster. Then, the amount of your normal mortgage payment that goes toward your principal increases and the amount that goes toward your interest decreases because less interest is being charged. Over time, these increases and decreases grow exponentially.
As an example, consider a loan of $300,000 with an amortization period of 15 years. If you pay an average interest rate of 5 percent over the course of the amortization and pay just one extra mortgage payment a year, you can cut a year and a half off of your amortization and save about $15,000 in total interest. If you take the same loan amount and mortgage rate but choose an amortization period of 25 years, you can shorten your amortization period by three-and-a-half years and save about $36,000 in interest. Both of these calculations were performed by taking the normal mortgage payment on each loan, dividing it by twelve, and adding the result to each month’s normal payment. Of course, paying more than one extra mortgage payment a year will lead to more dramatic results.
A second reason to follow prepayment for mortgage recommendations has to do with the benefits of getting out of debt. As you pay off debt, you have more disposable income to invest and otherwise spend on yourself and your family. Since your mortgage payment will likely be the largest expense you have each month, getting rid of it by paying off your mortgage loan is the best way to access more disposable income. You also have the benefit of greater financial security. Your personal economic situation may change over time due to job loss, promotions, a move, and other such things. While you are paying a mortgage, you will always have to worry about how changes in your personal economic situation will affect your ability to pay the mortgage. Pay off your mortgage early, and you will have these worries no longer.
Having seen all the benefits of paying off your mortgage faster, we will now conclude this resource page with a look at some practical ways to pay off your mortgage faster. If you can follow any of these steps, you will pay off your mortgage early and enjoy many benefits:
• Make a budget and cut the amount you spend on discretionary items so that you can devote more money toward your loan principal.
• When you get a raise, devote that extra money to your mortgage instead of spending it on something else.
• Take your tax refund and apply it to your mortgage.
• Apply a portion or all of any inheritance or other monetary gift toward your mortgage.
• If you are a dual-income household, try to live entirely or mostly on one spouse’s income. Devote the other income entirely or mostly to your mortgage.
• Consider switching your payment schedule to weekly payments. With weekly payments, you take the total that you would have spent on twelve monthly payments, divide it by fifty-two, and pay that amount every week. On a $300,000 mortgage with a 5 percent average fixed interest rate and a thirty-year amortization period, you will pay off your loan a few months early and save about $4,600 in interest over the life of the loan.
• Consider switching your payment schedule to accelerated weekly payments. With accelerated weekly payments, you take your normal monthly mortgage payment, divide it by four, and pay that amount every week. On a $300,000 mortgage with a 5 percent average fixed interest rate and a thirty-year amortization period, you will pay off your loan five years early and save about $53,300 in interest over the life of the loan.
• Consider switching your payment schedule to bi-weekly payments. With bi-weekly payments, you take the total that you would have spent on twelve monthly payments, divide it by twenty-six, and pay that amount every two weeks. On a $300,000 mortgage with a 5 percent average fixed interest rate and a thirty-year amortization period, you will pay off your loan a few months early and save about $4,000 in interest over the life of the loan.
• Consider switching your payment schedule to accelerated biweekly payments. With accelerated biweekly payments, you take your normal monthly mortgage payment, divide it in half, and pay that amount every two weeks. On a $300,000 mortgage with a 5 percent average fixed interest rate and a thirty-year amortization period, you will pay off your loan five years early and save about $52,800 in interest over the life of the loan.