By Sheryl Smolkin
A continuing debate among personal finance pundits is whether you should pay off your mortgage first or save for retirement, particularly in a low risk environment. The fact is you should probably do a little of both as frequently as possible. One strategy some experts advocate is to make an RRSP/SPP contribution and then use your tax return to decrease your mortgage balance, thereby reducing your amortization period and minimizing the total cost of your loan.
But whatever you decide to do, your goal should be to eliminate your mortgage entirely before you retire. By doing so, you will reduce your monthly expenses and minimize the impact the drop in income at retirement will have on your lifestyle.
How much you can pay down your mortgage and when will depend on the terms of the loan secured on your property. That’s why it’s important when you are negotiating or re-negotiating your mortgage to clearly understand the terms and what if any penalties you might incur if you deviate from the prescribed payment schedule.
Here are four ways to pay off your mortgage faster with examples as suggested by the Financial Consumer Agency of Canada:
1. Increase the amount of your payments
One of the ways to pay off your mortgage faster is to increase the amount of your regular payments. Normally, once you increase your payments, you will not be allowed to lower your payments until the end of the term. Check your mortgage agreement or contact your mortgage lender for your payment options.
For example, if John is getting a mortgage of $150,000 amortized over 25 years with a fixed interest rate of 5.45% for five years, minimum monthly payments amortized over 25 years are $911. If John pays just $50 a month more, it will only take 22.5 years to retire the mortgage and he will save $14,000.
2. Renew at a lower rate, keep payments the same
At the end of your mortgage term, when you renew or renegotiate your mortgage, you may be able to obtain a lower interest rate. Although you will have the option to reduce the amount of your regular payments, you can take advantage of this situation to pay off your mortgage faster. Simply keeping the amount of your payments the same will make you mortgage-free sooner.
Stephanie adopted this strategy when she renewed her $100,000 mortgage after five years and the interest rate dropped from 6.45% to 5.45%. While the lower interest rate would have reduced Stefanie’s monthly payments to $924, she decided to keep the monthly payments at $1,000 in order to reduce the total amount of interest payable over the term of the mortgage.By keeping the monthly payments at $1,000 per month with the lower interest rate for the rest of her mortgage, Stefanie will save over $12,000 and will pay off the mortgage two and a half years sooner.
3. Choose an “accelerated” option for your mortgage payment
You can spend approximately the same amount of money on your mortgage each month and still save money by choosing an accelerated option for making your payments. Most financial institutions offer a number of payment frequency options:
- Accelerated biweekly
- Weekly, and
- Accelerated weekly
Accelerated weekly and accelerated biweekly payments can save you thousands, or even tens of thousands in interest charges, because you’ll pay off your mortgage much faster using these options. The reason is that you make the equivalent of one extra monthly payment per year.
Let us assume that Richard has a mortgage of $150,000, amortized over 25 years, with a constant interest rate of 6.45%. If he chooses an accelerated payment frequency equivalent to one extra monthly payment a year, Richard will pay off his mortgage over four years sooner and save more than $29,000 in interest over the amortization period.
4. Making lump-sum payments: Prepayments
A prepayment is a lump-sum payment that you make, in addition to your regular mortgage payments, before the end of your mortgage term. The prepayment reduces your outstanding balance and allows you to pay off your mortgage faster.The sooner you can make the prepayment, the less interest you will pay over the long term, and the sooner you will be mortgage-free.
5. Key things to remember:
- Your mortgage agreement will specify whether you can make prepayments, when you can do so and other related terms or conditions. Read it carefully, and ask your mortgage lender to explain anything you don’t understand.
- If your mortgage lender is a federally-regulated financial institution such as a bank, as of January 2010, it must show your prepayment options in an information box at the beginning of your mortgage agreement.
- Your mortgage agreement may specify minimum and maximum amounts that you can prepay each year without paying a fee or penalty.
- The prepayment option is generally not cumulative. In other words, if you did not make a prepayment on your mortgage this year, you will not be able to double your prepayment next year.
- A closed mortgage agreement may require you to pay a penalty or fee for any prepayment.