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How to pay down your mortgage faster

How to pay down your mortgage faster

Posted on: March 26, 2012
Author: Staff

Mortgage rules depend on your lender and the type of mortgage you have, but in general, there are three ways you can pay down your mortgage faster: reducing your amortization, increasing your payment frequency, and taking advantage of pre-payment privileges.

Reducing your amortization

Amortization is the length of time you've committed to pay down your entire loan or mortgage. In Canada, the maximum amortization period is 25 years.

The longer your amortization, the lower your mortgage payments will be but the more you'll end up paying in interest. This is because the principal amount of your mortgage—your original borrowed amount—decreases at a slower rate, so more interest is accrued during the longer term.

Reducing your amortization allows you to minimize your interest payments and pay down the principal faster.

For example, using a $200,000 mortgage at 5% (per annum):

Amortization (assuming same interest rate over entire period) Regular payment Total interest costs (over the life of your mortgage) Interest saved
15 years $1,576.65 $83,724.57 $65,238.42
20 years $1,314.25 $115,420.02 $33,542.97
25 years $1,163.21 $148,962.99 N/A

 

Increasing your payment frequency

You can make your mortgage payments monthly, semi-monthly (twice a month), bi-weekly (every two weeks), or weekly. Semi-monthly and bi-weekly may seem like the same thing, but in reality, bi-weekly payments can save you thousands in interest and help you pay off your mortgage years earlier. This is because, with semi-monthly payments, you'll make 24 payments a year (two per month); with bi-weekly, you make 26 payments a year (half of the year's 52 weeks). That's two extra payments every year.

While bi-weekly payments offer a significant advantage to monthly and semi-monthly payments, weekly payments offer only slight additional savings. This is because, with weekly payments, it takes six years to slip an extra payment in the rotation, which makes little difference in the long run.

For many Albertans, it's most convenient to align mortgage payments with paycheques, but if your budget can accommodate the extra two payments of the bi-weekly option, you should go for it. As you can see, the savings can be huge:

Using a $200,000 mortgage at 5% (per annum):

Payment frequency Monthly payment Actual amortization (years) Total interest costs (over the life of the mortgage) Interest saved
Monthly $1,163.21 25 $148,962.99 N/A
Accelerated bi-weekly $581.60 22 $124,094.94 $24,868.05

 

Pre-payment privileges

Another mortgage option that may be available to you is through the use of pre-payment privileges. Open mortgages can be paid off at any time, whereas with a closed mortgage, you generally have to pay a penalty if you want to close early.

Thankfully, closed mortgage owners aren't stuck with their regular payments: many lenders allow you to increase your payments by 20% each year or prepay up to 20% of your loan each year. If you go over these limits, you will have to pay a penalty.

As with the previous two options, these pre-payment privileges allow you to pay down your mortgage faster.

Again, using a $200,000 mortgage at 5% (per annum):

Pre-payment choices Standard 25-year amortization Increase mortgage payments once by 20% and increased payment maintained Make payment of 20% ($40,000 at end of 1st year only)
Mortgage repaid in months 300 228 189
Total interest cost (over the life of the mortgage) $148,962.99 $106,750.64 $81,239.37
Interest saved vs. standard 25-year amortization N/A $42,212.35 $65,236.20

 

All of these options may not be available to you, so you should always check with your lender before you sign up for a mortgage or make changes to your existing mortgage.

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