This blog explores whether it’s a smart move to pay more than your minimum monthly balance to retire mortgage debt earlier than planned.
You’ve shopped around for a mortgage, using an online mortgage comparison tool. You select various payment frequencies, and receive some great recommendations, including what your payments will be if you opted for a smaller or larger property.
The online tool also conveniently highlights the new “stress test”, that the Office of the Superintendent of Financial Institutions’ (OSFI) introduced on Jan 1st, 2018, which you need to pass to be eligible for the mortgage of your choice. You’ve made your decision! Based on many lender recommendations the tool provides, you decide to go with an Accelerated Bi-weekly payment schedule.
But there’s one question that nags you:
Should you try and pay off your mortgage sooner, and if so, what impact will it make on your final debt load?
Making Sense of It All
To make sense of it all, you need to keep one basic tenant of mortgage repayments in mind:
All other things being equal, the longer it takes for you to pay down that balance, the more you’ll be paying in interest over the life of your term!
Let’s look at a slightly different example to illustrate our point.
Jane and her best friend Meg both opted for a $350K mortgage, amortized over a 25-year period, and both settled for a mortgage rate of 4%. They both decided to go with a monthly payment option (less frequently than the Accelerated Bi-weekly frequency we discussed in the earlier example). The lender calculates their monthly payments to be $1,841.
At this rate, they’ll have paid $202,321 in total interest over the life of their mortgages, and it will take them 25 years to pay off that loan.
Luckily for Jane, her spouse Joe got a slight pay raise last month, and he agreed to chip in with the monthly mortgage payments. He reviews his finances and discovers that he can contribute an additional $100 per month towards that mortgage.
Jane thinks to herself:
“Humm…Just $100 additional per month? What’s that going to accomplish?”
Well, according to the Financial Consumer Agency of Canada – quite a lot!
By contributing just $100 more a month towards their mortgage payments, Jane and Joe will not only pay off that balance 2-years earlier than planned, but they’ll also save over $19,000 in interest payments over that period. Now how cool is that!
However, not everyone can afford to “engineer” their finances each month, so that they can put aside an extra something towards debt retirement. Unfortunately, that was the case with Meg. She had other monthly commitments that didn’t allow her the flexibility to make additional monthly payments towards her mortgage.
So, what then? Is there no way for Meg to pay down her mortgage sooner, and save on interest? Well, there just might be…Read on to find out how that’s possible!
One and Done!
Just prior to the start of year 2 of the mortgage, Meg took a closer look at the mortgage contract and realized that the lender allows her to make “prepayments” of up to 10% of the original mortgage amount. These are annual privileged payments that borrowers can make, and which go directly to reducing the principal owed.
Meg took stock of her finances and discovered that she had a $10,000 GIC that would be coming up for renewal shortly. She realized that this would be a “One and done!” situation, because there wasn’t any additional savings that she could bring to bear on discharging her mortgage. She decided to use that money to make a lumpsum payment towards the principal outstanding.
Meg went to the lender and discussed her plan with him. When the agent did the math for Meg, the results were astonishing!
In making just that one single lumpsum payment of $10,000 at the beginning of year 2, Meg would be able to pay off her mortgage nearly 1 year ahead of schedule. But that’s not all! Over the life of the mortgage, she would save over $15,000 in interest! The “one and done” strategy not only saves her the GIC principal – but nets her nearly $5k over and above that amount!
David and Becky had a 5-year fixed, $350,000 mortgage, amortized over 25 years. They were paying a 5% interest rate when the term came up for renewal back in 2016 – when mortgage rates has gone down. They now were offered a renewal rate of 4% – a full percentage point lower than the existing rate.
The couple were paying $2,036 as their monthly payment against the original mortgage, but the new monthly payment on the $309,776 outstanding balance worked out to $1,872. The couple faced a dilemma:
“Should they pay the revised amount ($1,872) and save the rest, or should they continue to pay the same $2,036 following the renewal?”
The couple were split on their preference, with David wanting to stay the course, while Becky was hoping to “put something aside” in their Rainy-day fund. When they took the problem to their mortgage agent, she did the math for them – and the result left them both speechless!
If the couple reduced their monthly payments to the new norm (of $1,872), it would take them 20 years to pay off the balance. However, continuing with the previous monthly installment (of $2,036) would not only enable them to be debt free one year earlier (in 17-years and 8 months), but it would also save them nearly $18,000 in interest over the term of the mortgage.
The decision was a no-brainer for David and Becky: Since they had already adjusted their lifestyle, over the past 5 years, to live with a $2,036 monthly outlay for their mortgage, it wasn’t such a huge deal to continue doing so for the rest of the new term.
Pay it Off Quicker – It’s worth it!
If you are grappling with a decision on whether to go above and beyond and make that extra payment that will get you debt-free sooner, the answer is simple:
Just do it!
Making that additional one lumpsum or periodic additional payments will enable you to reap huge savings in the long run.
If you want to find out how much you could save by choosing various payment frequencies, from Monthly and Quarterly, to Weekly, Bi-weekly and Accelerated Bi-Weekly options, just use the online Mortgage Calculator here and see what the math says. You may just be surprised at how quickly you can pay down your mortgage, and how much you too can save by doing so!
You can check out the Financial Consumer Agency Calculator here!