During the last few weeks, I’ve worked with clients who expect changes to their finances in the next few months.
One couple purchased a home and have a rental property listed for sale. Their dream home came on the market and they were able to forward before selling the rental. When the rental property sells, they will have a significant amount of money to put toward their new mortgage.
Another family will be going from one full-time income to two when the husband finishes his schooling at the end of December. They really want to pay as much of their mortgage off as they can before they start a family.
By making thoughtful decisions and small changes, it is possible to reduce the amount of interest that you pay over the life of your mortgage. Comparing different interest rates, payment schedules, and amortizations may help save you thousands, and shave years off your mortgage.
If your goal is to pay down your mortgage as quickly as possible, it’s important to know the prepayment options allowed by your lender.
Amortization refers to the gradual repayment of a debt by means of partial payments on the principal at regular intervals.
The amortization period is the time required to repay your mortgage completely.
The amortization period you choose can have a dramatic effect on the amount of interest you pay over the length of the mortgage. Consider this example:*
$400,000 mortgage with an interest rate of 3.34 per cent*
- With a 25-year amortization the monthly payments are only $1,963.45
- With a 20-year amortization the monthly payments are increased by only $318.95 to $2,282.40.
In this example, by choosing a 20-year amortization, you save yourself almost $42,000 and your mortgage is paid off five years sooner.
Although a 25-year amortization is the norm, have your mortgage specialist prepare comparisons for you to show you the difference a slightly higher payment can make.
Most lenders offer clients the ability to increase their payment once a year. I generally suggest that my clients choose a 25-year amortization to start with, and have them increase the payment after based on what they feel comfortable with.
This way, if the higher payment proves to be more than they are comfortable with, they can reduce the payment without having to pay fees to re-write the mortgage.
As a general rule, the following prepayment provisions are available to you each year of the term of your mortgage (i.e. during the 12-month period starting from the date your mortgage is advanced, and then once each year):
- Increased payment – once per year, you can increase the amount of your regularly payment to a maximum predetermined by your lender. This amount is generally either 15 per cent or 20 per cent. The maximum for each payment increase is calculated using the amount of the current regularly scheduled payment in effect at the time.
- Lump sum payment – again, this depends on your lender. In many cases, you can make lump sum payment of $100 or more on any regularly scheduled payment date, provided the total of these prepayments made throughout the year does not exceed 15 per cent to 20 per cent (whatever the amount allowed by the lender) of the original principal amount of your mortgage.
Most mortgages have very flexible payment alternatives. Weekly, bi-weekly, or monthly payments are most common. These choices also have a great effect on the overall interest payments. Consider the following example*:
$400,000 mortgage at 3.34 per cent interest over a 5-year term 25 yr. amortization
SCHEDULE PAYMENT BALANCE (at end of term) INTEREST SAVINGS (over amortization)
Accelerated weekly $490.86 $333,293.85 $24,647.23
Accelerated bi-weekly $981.72 $333,338.04 $24,382.00
Monthly $1,963.45 $344,102.73
*The example assumes the interest rate will remain constant through the whole amortization period.
By choosing a payment schedule other than monthly, you can save a great deal of money over the life of your mortgage. As well, you will likely find it most convenient to choose the payment schedule that follows your pay day.
If you are unclear about the prepayment options for your mortgage, ask for clarification. I was going over options with a client last week. She is down-sizing and her goal is to be mortgage-free within five years.
She is very savvy and careful with her money. She was surprised to learn that she could make lump sum payments every year. She thought that she could only do a lump sum payment once each term (ie: once every five years).
I suggest clients do an annual check up of their financial situation and take a look at their family budget to see if there is an opportunity to pay down their mortgage quicker.
In our market this is not always practical, but life changes such as wage increases or not having to pay daycare bills can free up a little extra cash that can make a big difference to your bottom line.
There are many ways that you can pay your mortgage off ahead of schedule. By working closely with your mortgage specialist you can be mortgage-free years sooner.