Purchasing a home is a big step. Paying off your mortgage as early as possible will be the best investment you can make. Previous Canada Mortgage and Housing Corporation (CMHC) surveys have shown that 68 per cent of recent homeowners felt there was a strong chance they could pay off their mortgage more quickly than their amortization schedule. Some 27 per cent have either made additional lump sum mortgage payments or have increased their regular payment amounts.
This is a balance between paying off your mortgage quickly and still having a life – a night out or a vacation once in a while. Here are a couple of ways to shorten your mortgage without killing your social life.
Accelerated bi-weekly payments
Instead of paying your mortgage on a monthly basis 12 times per year, pay your mortgage every two weeks for a total of 26 half-monthly payments each year. This is like paying 13 full monthly payments per year.
Example: Assume your interest rate stays at 3% throughout your mortgage. A $300,000 mortgage paid on a monthly basis over 25 years will cost you $125k in interest. However, if you increase your payment frequency to accelerated bi-weekly payments, you will shave nearly three years off of your mortgage (22.3 years), and save over $15k in interest.
Note – as interest rates increase, the benefit increases. A 5% rate over the lifetime would reduce your amortization to 21.5 years and save some $36k in interest.
Round up your mortgage payments
Make no mistake: Every dollar counts when it comes to paying off your mortgage. The quicker you can pay down your mortgage, the more you will save. One painless way to make your mortgage disappear faster is to round-up your mortgage payments.
Most lenders will allow you to increase your base payment by up to 15% each year.
Example: Accelerated bi-weekly payments for a $250,000 mortgage with a 2.75% interest rate over 25 years would be $575.64. Increase those bi-weekly payments by just $24.36 to $600, and you’ll shave nearly four years off the regular monthly repayment time. It shortens your mortgage by over 1 year compared to the $575.64 biweekly payment and saves another $5k in interest.
Put ‘found’ money towards your mortgage payments
Unexpected sources of money such as a birthday cheque from a relative or a bonus at work are considered sources of ‘found’ money.
‘Found’ money can be easily applied to your mortgage without any impact to your budget because it wasn’t money you were expecting or counting on.
Consider increasing your RRSP contributions, and then put your tax refund directly towards the principal of your mortgage.
Example: A one-time payment of $5,000 on a $250,000 mortgage at 2.75% over 25 years will decrease your mortgage amortization by over 7 months. It will not only reduce your mortgage balance by $5k but also save you another $4k in interest.
Make a lump sum payment once per year
Almost every lender allows you to make extra mortgage payments each year. Anything extra you pay goes right to paying down your mortgage principle. Many lenders will let you make lump sum payments of minimum $100 per payment, as often as you wish, as long as they don’t add up to more than the allowed amount per year. For most lenders, that is 15% of the original mortgage balance.
This is another flexible approach to consistently chip away at your mortgage.
Example: An annual lump sum payment of $550 on a $250,000 mortgage at 2.75% over 25 years, combined with a bi-weekly payment frequency will decrease your mortgage amortization by some 3.7 years compared to monthly payments.
For most people, once you have a mortgage and start making your payments, you forget about it. It’s just another automatic payment. That is why simple steps like moving to accelerated biweekly payments and rounding up the base payment are great ideas. They get put in place once and then continue on auto-pilot.
With a lender that allows you to increase your payments by up to 15% per year and put another 15% of your mortgage down in lump sum payments each year – you could be mortgage free within a typical 5 year term. You may not eat much more than stone soup and kraft dinner – but its possible.
Some couples will buy on the basis that one income can pay the minimum mortgage plus all house bills and lifestyle expenses. The second income goes directly to the mortgage in increased payments and lump sums. I have had clients pay their mortgage out within 5 years. They are typically under the age of 30 – no kids – and are driven to achieve this milestone in life. And, when they do, they walk with a freedom that most others can’t imagine at that age.
In the background, we are also watching market rates and comparing it to our current clients existing mortgages. Sometimes it makes sense to pay a penalty to get out of a higher interest rate mortgage. You can move to lower current rates in the market. We watch for this and will – and do – call you to let you know about that opportunity.
We are here not to help you get into debt but to position you with the right mortgage solution – and strategies to get out of your mortgage and into true home ownership as quickly as possible.