How to Pay Your Mortgage Off Faster
Any additional payment you make on your mortgage (also called
pre-payment) will save you a lot of money in interest. Every normal
payment you make consists of principal and interest. The interest
portion of your payment is determined by the outstanding balance of
your mortgage. As the outstanding balance diminishes, less of your
payment goes towards interest and more comes off the balance.
Example – Principal vs. Interest
| Mortgage balance |
Rate |
If the payment is |
|
Amount applied to principal |
|
Amount applied to interest |
| $150,000 |
6.45% |
$1,000 |
= |
$205 |
+ |
$795 |
| $100,000 |
6.45% |
$1,000 |
= |
$465 |
+ |
$535 |
| $50,000 |
6.45% |
$1,000 |
= |
$730 |
+ |
$270 |
The faster you reduce the outstanding balance on your mortgage, the
more you will save in interest charges. Since pre-payment policies vary
between institutions and types of mortgages, you should consult your
mortgage agreement to fully understand the pre-payment options that may
be available to you. Some ways to minimize your mortgage costs are:
Accelerated bi-weekly payment option
A good way to shorten your amortization may be to choose the
accelerated bi-weekly payment option. This allows you to pay half of
your monthly payment every two weeks. By doing this, you end up making
the equivalent of one extra monthly payment a year. To see how this
works, see the following example.
Suppose you pay $1,000 per month for your mortgage. Since you make this payment 12
times a year, your payments total $12,000 at the end of the year.
Let's
assume that you decide to make your payments every two weeks. Your
payments will be $500 every two weeks ($1,000 ÷ 2) and you will make 26
payments (52 weeks ÷ 2) for a total of $13,000 at the end of the year.
The following example illustrates how much you can save in
interest charges if you choose the accelerated bi-weekly payment
option, assuming your mortgage is $150,000, at 6.45 per cent, amortized
over 25 years.
Example – Accelerated bi-weekly payment option
| |
Monthly |
Accelerated bi-weekly |
| Payment |
$1,000 |
$500 |
| Amortization |
25 years |
22.58 years |
| Interest paid |
$150,059.80 |
$120,648.46 |
| Interest saved |
-- |
$ 29,411.34 |
Similar interest savings can also be obtained with the
accelerated weekly payment option. If you decide to make your payments
every week, your payment will be $250 every week ($1,000 ÷ 4). You will
make 52 payments (52 weeks) for a total of $13,000 at the end of the
year.
Keeping the same payments if you renew at lower rates
At the end of your term, when you renew or re-negotiate your
mortgage, you may be able to obtain a lower interest rate, which will
reduce your future payments.
An easy way to accelerate your mortgage payments is to maintain the
same payments you were making during the previous term. The difference
between your previous payments and your current (lower) payments will
be applied to the principal, to reduce your mortgage balance and help
you pay your mortgage down faster.
This is one of the easiest ways to pre-pay your mortgage, since it
does not affect your budget and spending habits (you accelerate your
mortgage payments, while continuing to make the payments you were
accustomed to making during the previous term).
The following example shows how your new, lower interest rate allows
you to make pre-payments of $200 per month, while keeping the same
payment you had during the previous term.
| |
Previous term |
Current term |
Interest rate
Monthly payment
Minimum payment required
(given mortgage interest rate)
|
7.5%
$1,100
$1,100 |
5.5%
$1,100
$900 |
| Difference - additional amount applied directly to the principal to further reduce your mortgage balance |
$0 |
$200 |
Increasing the amount of your payments
Most lending institutions will allow you to increase the amount of
your mortgage payments. Some institutions allow an increase once a
year; others, only once per term.
The amount of increase allowed varies by lending institution and by type of mortgage, and can be as high as 25 per cent.
For example: If your current mortgage payment is $1,000 per month,
you may be able to increase it by $200 to $1,200 per month ($1,000 ×
20% = $200). The extra portion of the payment is applied as principal
against the outstanding balance of your mortgage and accelerates your
mortgage repayment.
The disadvantage is that this increase may be permanent (depending
on the lending institution), and it may be difficult to bring your
payments back to their original amount. You should therefore make sure
that you can handle new, higher payments until the end of your mortgage
term.
Making lump-sum payments
Most lending institutions will allow you to make lump-sum payments
against the principal. Since these amounts are applied to the principal
only, they reduce the outstanding balance of your mortgage.
The amounts allowed vary by lending institution and by type of
mortgage and can be up to 20 per cent, and sometimes more, of the
original amount of your mortgage. If you borrowed $100,000 originally
and your institution allows you to make lump-sum payments of up to 15
per cent, you will be allowed to pay up to $15,000 extra every year.
You can usually only do this once a year, and your institution generally determines when it can be done.
This pre-payment option is not cumulative. In other words, if you
did not make additional payments on your mortgage this year, you will
not be able to accumulate the percentage of pre-payment allowed and
double your pre-payment next year. In the example provided, you would
not be able to double your payment from $15,000 to $30,000, because you
did not make a payment last year.
Paying extra on your payment dates
Most lenders will allow you to make additional payments on your
mortgage, sometimes referred to as "double-up" payments. These extra
amounts are applied to the principal only and reduce your mortgage
balance, which helps you pay your mortgage off faster.
Although there are some limitations, which vary by institution and
by type of mortgage, you can generally double your normal mortgage
payment on any payment date. Some lenders may let you decide how much
extra you want to pay (i.e., they may allow "partial doubling") and
when you can pay it. Your lender might even agree to automatically
withdraw the money for the extra payment from your account each payment
date.
With double-up payments, the limits on your payment increases are
not as strict as with the pre-payment option outlined earlier (100 per
cent rather than up to 25 per cent), and you may stop making double
payments at any time.
Some institutions, however, may deduct your total extra payments
from the amount of the lump-sum payment you are allowed to make.
For example, let's assume that your monthly payments on your
original $100,000 mortgage are $1,000 and that you decide to make an
extra $500 payment each payment date, and that your institution allows
"partial doubling" of the payment amount. Let's also assume that your
institution allows you to make lump-sum payments of 15 per cent of your
original mortgage every year. Here is how some institutions will
determine your maximum lump-sum amount for a given year.
When shopping around, it is important to ask the lender what the
prepayment options and conditions are, so you can determine the best
prepayment option for you.
Source: Financial Consumer Agency of Canada
