The Mortgage Prepayment Options In Canada

A mortgage prepayment is the ability to pay beyond your allocated monthly payment against your mortgage, therefore meaning you will pay off your mortgage in a shorter amount of time and create less interest over time. This sounds perfect if you have the funds available, right? However, it isn’t always that simple, and it is essential to understand your mortgage agreement’s specific terms and conditions before you go down this route.

There are two different options with allowable prepayments. You can either get an increased allowance on your monthly mortgage payment. This means you can add to your usual monthly payment, therefore reducing your amortization period slightly. For example, you could be paying $2,000 per month and increase it to $2,250. You are actually allowed to go as far as to double your monthly payment if you have the capability.

The other option is a lump sum provision which allows you to put a larger sum of money against your mortgage principal. A study released by CAAMP suggested that in 2010, 28% of Canadians had taken advantage of a prepayment option. A lump sum provision is limited to 25% of your outstanding balance. However, this also means that you could technically pay off your mortgage within four years if you chose to.

It is quite simple that making further payments towards your mortgage will reduce your loan’s amortization period.

Therefore, over time, you will pay less interest and save money. However, there are potential downsides. For example, let’s say you increased your contributions to your mortgage by $500 per month and managed to save yourself $50,000 in interest payments over the entire period of your mortgage in the process.

If you had chosen to invest that $500 per month over the same period of time, it is entirely possible you could have achieved greater than $50,000 in returns. This is what would be described as an opportunity cost.

An alternative method to accelerate your mortgage term and reduce your amortization period is to change from a monthly mortgage payment period to a weekly (or accelerated bi-weekly). You can avoid paying penalty fees by changing your payment period but still achieve the ability to accelerate your mortgage amortization. More frequent payments can actually take years off your amortization.

As an example, let’s say you spend $1,000 per month on your mortgage. This means you spend $12,000 per year on your mortgage ($1,000 x 12). If you were to move to a weekly payment plan, you would be paying $250 per week but $13,000 per year ($250 x 52 weeks). This means you pay an extra $1,000 per year against your mortgage without really feeling the impact. This clearly illustrates that more frequent paying options applied to your mortgage can reduce your mortgage amortization significantly. It is not uncommon to impact this so much that you can pay off a 25-year mortgage in 20-22 years, therefore saving yourself years’ worth of interest payments.

Another option is to combine your mortgage with your current account. This means that every payment made into that current account will reduce your mortgage. However, each withdrawal will increase it. Therefore, based on a net cash flow into/out of the account, your mortgage will be impacted.

For example, let’s say you earned $50,000 net of tax within the year, which was transferred into your bank account. You then spent $20,000 on food and general living costs out of that same account. Your mortgage would reduce by $30,000 ($50,000 – $30,000 = $20,000). However, it is definitely worth discussing this option with an expert, and potentially those close to you. This isn’t an option suitable for those who don’t have strong control over their budgeting and finances.

Your personal situation can change so significantly during the term of your mortgage. For example, you may get a new job that pays significantly higher or gets a huge unexpected bonus. Therefore, your desire to pay off your mortgage sooner can significantly change as well; it is just difficult to predict.

Significant cash-flow increases during your mortgage term are not uncommon, and many people experience it. Putting this increased cash-flow towards your mortgage can significantly reduce the total amount of interest that you will pay and allow you to live mortgage-free at a faster rate than your original mortgage term had dictated.

In a survey conducted by CAAMP, a total of 84% of Canadians claimed that they believed they could pay at least $300 more per month against their mortgage payments.

Many Canadians have shown that they do like to take advantage of prepayment options to reduce their owe on their mortgage. In 2011, 16% of prepayments increased their monthly payments, 5% increased the frequency of their payments (e.g. moved from a monthly payment to a weekly payment), and 17% took advantage of putting a lump sum of up to 25% against the remaining balance of their mortgage.

Some lenders will impose a penalty if you pay more than the allowed additional amount towards your mortgage.

It is important to understand your mortgage’s terms and conditions to fully understand the potential consequences of paying further amounts towards your mortgage. Prepayment penalties have the potential to cost thousands of dollars.

Discuss your options with your mortgage broker or lender to find out exactly where you stand when it comes to potential penalties or fees.