I recently read about the results of a survey asking Canadians at what age they expect to be mortgage free and the average was 58 years old, one year older than the results of the same survey question asked last year. Is that the answer you expected? If it’s a little higher than you thought or want for yourself, keep reading…. There are ways to be mortgage free faster and one of the quickest ways is to utilize your pre-payment privileges. This article is about how to reduce your mortgage balance owing while avoiding any out of pocket penalties. My first suggestion in getting started on the right path is to consult a financial planner for wealth building strategies in order to learn how to get the most out of your employment earnings. For now let’s start with reducing the biggest debt you’ll likely take on, your mortgage.
There are basically 4 ways to pay your mortgage off faster. Increase your payments, increase the frequency of your payments, pay a lump sum, or shorten your mortgage amortization. The advantage of pre-payment privileges is any additional funds you pay over and above your minimum mortgage payment will go directly towards your mortgage principal. This is because the interest cost is always satisfied first on a mortgage loan while the remainder of the payment will go directly to paying down the principal. By lowering your principal, you will save on interest and your balance at the end of your term will be lower.
Your first step is to review your original mortgage commitment to find out what pre-payment privileges your current mortgage term will allow without penalties. Next, you need to decide exactly how much you can afford to increase that payment at this time in your life and then call your lender. Even a small increase in the payment amount will help pay the mortgage off faster. The good part of manually increasing your payment is if at any time your financial circumstances change, you can always call your lender and ask them to reduce the payment back down to what it originally was before the increase. The norm in the mortgage market today for prepayment options is a 15-20% payment increase yearly and up to 15-20% lump sum yearly (which most often can be paid throughout the year in various increments). Some lenders also offer a double-up payment and/or a skip a payment option.
Here are some examples of how you can save money by utilizing your mortgage pre-payment privileges;
Example: Karyn has a mortgage of $300,000 with a fixed interest rate of 3%. She has 3 years remaining on her 5-year term and 23 years left in her amortization. She currently has a monthly mortgage payment frequency.
INCREASING MORTGAGE PAYMENT FREQUENCY.
By going from monthly to accelerated bi-weekly payments, Karyn will;
– Reduce her mortgage balance by an extra $4750 by the end of her term
– Shorten her overall mortgage amortization by over 2 years
– Only pay an extra $126 a month
INCREASE MORTGAGE PAYMENT AMOUNT
By increasing her monthly mortgage payment by 10% for the remaining 3 years of her term, she will;
– Reduce her mortgage balance by an extra $5600 by the end of her term
– Reduce her overall amortization by over 2.5 years
– Only pay an extra $150 a month
LUMP SUM PAYMENT ONCE YEARLY
Karyn received a bonus at work so she paid off her personal debts and paid a lump sum of
$2500 towards her mortgage principal only once during her remaining 3 year term, she will;
– Reduce her overall mortgage amortization by 3 months
– Save $2300 in interest
OR, if Karyn can afford to pay an extra $200 per month on her mortgage to pre-pay $2400/year for the last 3 years of her term, she will;
– Reduce her overall mortgage amortization by 9 months
– Save $6100 in interest
SHORTEN YOUR MORTGAGE AMORTIZATION
There is also a fourth way to pay off your mortgage sooner and that is by taking a shorter mortgage amortization initially. The main difference between this option and utilizing your pre-payment privileges while taking a longer amortization is that you are committed to higher mortgage payments from the get-go. If you take a longer amortization, 25 years being the average, you will have a lower mortgage payment with the option of pre-paying with extra cash if you are able. With a shorter amortization, you’re mortgage payments will be higher and there will be trouble if you can’t meet them due to any changes in your finances.
As you can see, you can save money and time by utilizing your pre-payment privileges. Keep this in mind if you are considering getting a new mortgage, though, be aware of the low rate “no-frills” products out there that have greatly reduced pre-payment privileges in exchange for a discounted interest rate. As you can see there are a number of ways to pay off your mortgage sooner and don’t be afraid to consult with some professionals in determining the best way to achieve your financial dreams sooner.