Owning a home in Canada is a significant achievement, but the journey to full homeownership involves managing a mortgage. This article is your guide to understanding and harnessing the potential of mortgage pre-payment privileges, a smart strategy that can save you money and bring you closer to paying off your mortgage sooner than you thought possible.
What Are Pre-Payment Privileges?
Before we delve into the different ways you can use pre-payment privileges, let's grasp the basics. Your mortgage has two main components: the principal and the interest. The principal is the original amount you borrowed to purchase your home, and the interest is the cost you pay to the lender for borrowing that money. Every mortgage payment you make is divided between reducing the principal and covering the interest.
Pre-payment privileges empower you to make extra payments towards your mortgage, separate from your regular monthly payments. These extra payments go straight towards lowering the principal, effectively shrinking the amount you owe faster and reducing the interest you'll need to pay over time.
Four Effective Ways to Utilize Pre-Payment Privileges
1. Lump Sum Payments
Imagine being able to make extra payments beyond your usual monthly mortgage installments. That's what lump sum payments allow you to do. You can contribute fixed amounts or percentages of your principal mortgage amount, depending on the terms set in your mortgage agreement. These additional payments are designed to shrink your original mortgage amount, ultimately leading to lower interest payments over the life of the loan.
Lump sum payments can be executed in four ways:
Before your mortgage term ends.
At the end of your term.
On specific dates outlined in your contract.
During specific times throughout your mortgage term.
Here's a markdown table showing the prepayment difference for a mortgage of $500,000 at an interest rate of 5.54% and 25 year amortization, compounded semi-annually, using different lump-sum payment options. Please note we will use this scenario throughout the blog.
Annual Lump Sum | Total Interest Paid (Life) | Mortgage Payoff Time |
None | $419,082 | 25 years |
$1,000 | $393,808 | 23 years, 9 months |
$2,500 | $371,714 | 22 years, 7 months |
$5,000 | $319,283 | 19 years, 9 months |
*Disclaimer below
In this table, the "None" row represents the scenario where no additional annual lump sum payments are made. The subsequent rows show the impact of making annual lump sum payments of $1,000, $2,500, and $5,000 at the end of each year, respectively. As you can see, making these lump sum payments accelerate the mortgage payoff time and results in significant interest savings.
2. Increasing Regular Payments
If you find yourself in a position to comfortably increase your regular mortgage payments, this strategy can pay off immensely. By discussing this option with a mortgage broker and ensuring it's allowed, you can boost your bi-weekly or monthly payments. This acceleration can significantly expedite your journey towards a mortgage-free life and reduce the total interest you pay.
Payment Type | Monthly Payment | Mortgage Payoff Time |
Standard Monthly | $3,063.61 | 25 years |
Rounded-Up Monthly | $3,100.00 | 24 years, 5 months |
*Disclaimer below
In this comparison, the "Standard Monthly" payment type refers to the regular monthly payment without any extra payments. On the other hand, the "Rounded-Up Monthly" payment type involves rounding up the standard monthly payment to the nearest hundred and making that rounded-up amount the monthly payment (+$36.39/m). This approach results in paying off the mortgage faster and saving significantly on interest payments ($12,026) over the life of the loan.
3. Double-Up Payments
No, we're not talking about a double-double coffee – we're talking about doubling your mortgage payments. Double-up payments allow you to make an additional payment equivalent to your regular mortgage payment. While not all lenders offer this option, some provide the opportunity once a year. This can be particularly advantageous if you receive bonuses, pay raises, or any extra income on a regular basis.
Payment Type | Total Interest Paid (Life) | Mortgage Payoff Time |
Standard Monthly | $419,082 | 25 years |
Double-Up Payment | $126,929 | 8 years, 7 months |
*Disclaimer below
In this table, the "Standard Monthly" payment type refers to the regular monthly payment ($3,063.61) without any extra payments. The "Doubled-Up Payment” payment represents a scenario where a doubled-up payment (total of $6,127.22) is made for every payment. Both the "Standard Monthly" and "Doubled-Up Payment" scenarios have different monthly payment amounts, with the latter strategy drastically reducing the interest paid and shortening the mortgage payoff time by more than 16 years sooner.
4. Accelerated Payment Options
By opting for accelerated payment options, you can make weekly or bi-weekly payments instead of the typical monthly schedule. This might sound simple, but it's a powerful method to chip away at your mortgage paying it off 2 to 3 years sooner. By the end of the year, you'll have essentially made an extra monthly payment, effectively reducing both your principal and interest payments.
Payment Frequency | Payment | Total Interest Paid (Life) | Mortgage Payoff Time |
Weekly | $705.75 | $417,473 | 25 Years |
Weekly Accelerated | $765.90 | $345,180 | 21 years, 2 months |
Biweekly | $1,412.24 | $417,956 | 25 Years |
Biweekly Accelerated | $1,531.80 | $346,019 | 21 years, 3 months |
Semi-monthly | $1,530.06 | $418,036 | 25 Years |
Monthly | $3,063.61 | $419,082 | 25 Years |
*Disclaimer below
Please note that these calculations are based on the provided mortgage amount, interest rate, compounding frequency, and different payment options. The "Standard" payment type refers to regular payments without any prepayments, while the "Accelerated" payment type includes additional payments equivalent to one extra payment per year.
Navigating Potential Pitfalls
While pre-payment privileges are undeniably beneficial, it's crucial to be aware of potential financial penalties that might come with them. Some lenders impose penalties for pre-payment, especially if it occurs during restricted periods or exceeds certain limits. To avoid unpleasant surprises, it's wise to consult a mortgage broker before making use of pre-payment privileges.
Harnessing the Benefits
Pre-payment privileges are valuable tools for Canadian homeowners. They empower you to take control of your mortgage, pay it off faster, and save significantly on interest payments. Whether you choose lump sum payments, higher regular payments, double-up transactions, or accelerated options, each step you take towards reducing your principal balance is a step closer to debt-free homeownership.
Remember, to make the most of pre-payment privileges, you should:
Understand the terms and conditions associated with your specific lender.
Consider any potential penalties and restrictions.
Calculate the impact of extra payments on your overall mortgage.
Conclusion: A Path to Financial Security
In todays real estate market, mortgage pre-payment privileges are a potent tool for securing long-term financial freedom. By making smart use of these privileges, you're not only investing in your home but also taking charge of your financial future. So, whether you're a seasoned homeowner or just stepping into the realm of property ownership, remember that with the right approach, pre-payment privileges can pave the way for a brighter, debt-free future. Your mortgage isn't just a monthly payment; it's an opportunity to shape your financial destiny.
*Disclaimer: Please note that these calculations are approximate and based on the provided mortgage amount, interest rate, and compounding frequency. The actual savings and payoff times may vary based on the specific terms of your mortgage agreement. It's always a good idea to consult with your lender or a financial advisor to understand how making rounded-up payments could benefit your unique situation. Rates are subject to change without notice. The purposes of this article is for illustrative purposes only. This is not a commitment to lend, pre-approval or approval.