How to Pay Your Mortgage Faster Tips on how to pay your mortgage faster
Prepayment Privileges and Penalties
Who cares about pre-payment privileges and how they work? Every client I’ve ever dealt with was keen on interest rates. In fact, it seems to be the most frequently sited metric used when shopping for a mortgage. In all likelihood, this stems from the need for having a common denominator to compare the hundreds of different options out there. The more sophisticated shoppers will differentiate between the no-frills and standard mortgage products. At the end of the day, almost no one understands how pre-payment privileges work. Every time you see or hear an add where you are being offered a way to save thousands in interest and be mortgage free years sooner – this is what they’re talking about.
There is no magic at work here – no secret recipe. The only way to pay off your mortgage sooner – is to pay more early on in the game. One way or another, it always boils down to using your prepayment privileges. In this article I wanted to cover the basic privileges you get and how they can be used to help you save. The game plan is to cover lump-sum payments, increase payments, accelerated payments and wrap up with a quick note on prepayment penalties. As always, your feedback and questions are appreciated.
This feature lets you make extra payments outside of your regular payment schedule. In other words, if you come by some extra cash or want to empty out your piggy bank at the end of the year, this option will tell you the rules. These payments will have a minimum (e.g. no less than $100 per transaction) and a maximum (e.g. no more than 20% of your principal balance in any one calendar year). Some banks will only allow you to make 1 payment per calendar year whereas others will let you make as many as you want so long as the minimum and maximum thresholds are not exceeded. Many great strategies exist for putting this option to work for you, but my personal three favourites are: Piggy Banking, Tax Refund Drop, and Bonus Sharing.
The idea behind Piggy Banking is to take some spare change from your debit account on a regular basis and dump it into a savings account. Every bank will allow you to set up a recurring funds transfer plan to help you save and most will not charge you for the transactions. If you can afford your Starbucks every day, you should have no problem with having five buck snuck out of your account daily. At the end of the year this will make a savings of $1,825.
Tax Refund drop is a commitment you make to yourself for putting your entire tax refund into your mortgage as soon as you get it. To make sure you keep faithful, you can give the CRA your savings account number as the destination for your annual refund. This will keep you from spending it on yet another thing you probably don’t need.
Finally, some of us are luckier than others when it comes to bonuses, but if you do get one at the end of the year – share it! Use half of it for buying presents and throw the other half into your mortgage. The great thing about these strategies is that they do not have a significant impact on your monthly budget yet they can go a long way. Using all three, let’s say your tax refund is $2,000 and your bonus is another $2,000, – that makes it $4,825 at the end of the year (1,825 + 2,000 + [2,000 / 2]). Did I mention every penny of that is going straight against your principal balance and none to interest?
When you opt to pay more every month two things happen. First, every penny you ‘overpay’ goes directly towards your principal, and second, the increase can always be reversed if you no longer wish to use it. Once again this option will have a cap (e.g. you can increase your payment by up to 20%) but you are never given an “all or none” ultimatum. This means that if you can only afford a 5% or 10% increase then you can make that call. Should your financial circumstances change, you can always cancel this increase and revert back to your original payment without any penalty.
The way this feature works is that you pay half of your monthly payment every two weeks or a quarter each week. With 52 weeks in a year and only 12 months, this means that if you are to pay every two weeks – you will make 26 half-month payments. The bottom line is, you’re making one extra monthly payment per year. As always, the entire amount goes directly towards your principal balance and none of it goes to interest. This helps shave off a few years off of your mortgage and saves you thousands of dollars. As always, no magic – just extra payments!
Penalties for overpayment
So that’s all good and well, but what if you need to pay more, or if you need to repay the whole thing (e.g. sell the place, or refinance)? This is why it is important to understand how your prepayment penalties work. Penalty terms will range from product to product and one lender to the next. The worse by far, are trust companies, followed closely by major banks on their fixed rate mortgages. The next worst are the specialty products where the penalty is determined based on a percentage of the outstanding balance, and finally, the rest. Fully open mortgages and secured lines of credit may offer no penalty at all, but holding large balances on those is oftentimes not the best idea as their interest rates are considerably higher.
The best thing you can do is to bring up your concern with each potential banker and/or broker and have them explain their options in greater detail. You would never think of shopping for a car with only one criteria in mind, so why would you limit your criteria to rate alone when looking for a mortgage? Prioritize the importance of each feature to you and make an educated decision rather than chase the ghost of a best rate offer.
Believe me when I tell you that knowing these things will not make you the center of attention at your next dinner party. But when put to good use and kept to, these can save you tons of cash. If you want to know how much, give me a call or email me and I’ll be glad to run the numbers for you free of charge
My Best Rates
1 year 2.79%
2 year 2.04%
3 year 2.09%
3 year 2.10%
5 year 2.20%
5 year 3.20%
Ivan Yakovlev, AMP
After doing an undergrad degree at York University, I found myself looking at several career paths. I love being a mortgage broker in Toronto. What I do lets me make a tangible positive difference in people’s lives.