Pay your mortgage off faster.
And reduce your mortgage penalty at the same time.
Looking for a way to reduce your mortgage penalty? It’s simple; pay your mortgage off faster!
Before we look at ways to pay your mortgage off faster, let’s look at some mortgage basics.
Every time you make a payment on your mortgage, the money is first used to pay off interest, and then the remainder is applied to the principal amount. When you first get a mortgage, most of your payment ends up going towards interest. For instance, if you borrow $150,000 at an interest rate of 5% your monthly mortgage payment is going to be about $872. Of that mortgage payment a whooping $619 is going to interest with only $253 going towards paying down the principal. At the end of the first month, your balance is still $149,746.
Assuming you continued to make that mortgage payment for the entire 25-year amortization period you would have paid a total of $261,722 for that $150,000 original mortgage. By paying off the principal as quickly as possible, you not only reduce your interest charges but you reduce your mortgage penalty if you ever need to terminate your mortgage agreement.
Here are a few simple ways to pay your mortgage off faster:
1) Increase your regular payments by a small amount: This could potentially save you thousands of dollars in interest and reduce your mortgage penalty significantly. Here’s an example to illustrate how. Let’s say you borrowed $200,000 at a fixed rate of 4% and are paying that off in monthly payments of $1,052.04 over a 25-year period. At that interest rate, you’ll end up paying $315,612 over the lifetime of your mortgage: $115,612 in interest alone! Let’s say you increase your monthly payment by just over $50, from $1,052.04 to $1,105.93. Not only will you pay off your mortgage 2 years faster, but you’ll reduce your total payments to $305,237 – a saving of over $10,000 in interest.
Now suppose that after the first 5 years you need to get out of your mortgage agreement, which has a term of 7 years. In the first case, your balance will be $174,108, whereas in the second case, your balance will only be $170,538. The difference of $3570 (a 2% reduction) would reduce your mortgage penalty by the same percentage.
2) Choose accelerated biweekly or weekly payments: Rather than pay monthly, why not opt for accelerated biweekly or even weekly payments? It’s equivalent to making one extra monthly payment per year. For example, instead of 12 monthly payments of $1000, you’d have 26 payments of $500, or 52 payments of $250. By increasing your total payments for the year by $1000 and by paying more frequently, you’d reduce your interest charges and therefore bring down your balance faster.
3) Make a lump-sum prepayment: Most lenders allow you to make lump-sum payments in addition to your regular payments. This is often limited to 20% of the original amount borrowed per year, but the exact timing and amount that can be paid without penalty is specified by your mortgage agreement. So if you come across some extra money – a bonus at work, a tax refund on your RRSP contributions – why not put it towards a prepayment on your mortgage? This goes directly to reducing the principal amount, thereby lowering interest and reducing potential mortgage penalties.
Note that usually prepayment options are not “cumulative”: if you don’t make a prepayment one year, then you can’t double the allowable amount the following year. So it’s important not to lose the opportunity to make a prepayment when you have cash available.
4) Be aware of your options: It’s important to keep up-to-date on current mortgage deals. Even if you have to pay a mortgage penalty to switch to a new mortgage agreement with a lower interest rate, you may still end up saving money. If you obtain a lower rate, keep your regular payments the same to reduce your balance faster.
5) Increase your payments with your pay increases: It’s easy to become complacent about mortgage payments. But if your income goes up, use the opportunity to boost your regular mortgage payments.
Just remember: a big chunk of your regular mortgage payment is probably going towards interest. By taking steps to reduce the amount you owe – increasing the frequency or amount of your regular payments, or making lump-sum prepayments with extra cash – you can save a huge amount in interest. You also gain flexibility by reducing the mortgage penalty that you have to pay to break a closed mortgage agreement.