Buying a home is probably the biggest investment you’ll make. Paying off your mortgage faster is a good way to save on interest costs and shorten your amortization period. But you need to be aware of the potential penalties this could generate. Here’s everything you need to know about mortgage prepayments and how a mortgage broker can help you make smart decisions.
Mortgage prepayment: Which option should you choose?
There are several ways to pay off your mortgage sooner and save on interest.
Increase your payment amount
Example: Sylvie has a $300,000 mortgage amortized over 25 years with a fixed interest rate of 5% for 5 years. Her minimum monthly payment $1,744.81. Let’s see what a $100 increase in her monthly payment would do.
| Monthly payment of $1,744.81 | Monthly payment of $1,844.81 | |
|---|---|---|
| Principal | $300,000 | $300,000 |
| Interest | $223,444 | $200,684 |
| Total amount paid | $523,444 | $500,684 |
| Interest savings | – | $22,760 |
| Amortization period | 25 years | 22 years and 9 months |
Accelerate your payment frequency
Example: Felix has a $300,000 mortgage amortized over 25 years at a fixed rate of 5% for the entire amortization period. His monthly payment is $1,744.81. Let’s look at the impact of different payment scenarios.
| Payment Frequency | Number of payments / year | Monthly payment | Annual payments | Interest savings | Amortization period |
|---|---|---|---|---|---|
| Monthly | 12 | $1,744.41 | $20,897.28 | – | 25 years |
| Accelerated biweekly | 26 | $872.41 | $22,682.66 | $37,302.23 | 21 years and 6 months |
| Accelerated weekly | 52 | $436.20 | $22,682.40 | $37,710.67 | 21 years and 5 months |
Make lump-sum payments
During the term of your mortgage, you can make one-time lump sum payments on top of your regular payments.
Example: Julie has a $300,000 mortgage amortized over 25 years at a fixed rate of 5% for the entire amortization period, and her annual prepayment limit is 10%, or $30,000. Let’s look at the result.
| Without prepayment | With prepayment (at the end of 1st year) | |
|---|---|---|
| Lump-sum prepayment | – | $30,000 |
| Principal | $300,000 | $300,000 |
| Interest | $223,444 | $148,440 |
| Total amount paid | $523,444 | $448,440 |
| Interest savings | – | $75,004 |
| Total repayment period | 25 years | 20 years and 5 months |
Advantages of prepayment
Increasing the rate at which you pay off your mortgage can save you thousands of dollars in interest costs in just a few years. By repaying the principal faster, you’ll actually pay less interest, because interest is calculated on your remaining mortgage balance. What’s more, lowering your principal balance faster will help at renewal time should mortgage rates go up.
Making prepayments will also shorten the total duration of your loan. By increasing your payment amounts or making lump-sum payments, you’ll shorten the loan’s amortization period and increase the equity in your home sooner. This means that the equity you’ve unlocked can be used to help finance your other projects!
Prepayment penalties
If you have a closed mortgage, your lender may impose penalties if you pay off all or part of your mortgage faster than stipulated in your contract.
Financial institutions use two methods to calculate prepayment penalties.
- For closed variable-rate mortgages, the penalty is often equivalent to three months’ interest, based on your current interest rate.
- For closed fixed-rate mortgages, lenders apply the greater of three months’ interest or the interest-rate differential, which is the difference between your rate and the financial institution’s current rate for the term remaining.
Tips for avoiding prepayment penalties
Did you know that with an open mortgage, you can pay off all or part of your mortgage at any time, without penalty? In exchange, you pay a higher interest rate than what you’d get with a closed mortgage.
If you’ve opted for a closed mortgage, there are ways to accelerate the payment of your mortgage without paying any fees. Before you do anything else, take the time to check the limits set by your lender in your mortgage contract.
If you would like to make a larger prepayment, we strongly recommend waiting until your renewal to do so. At the end of your term, you can pay off any amount of your principal balance without penalty and negotiate new terms for your loan.
The importance of using a mortgage broker
From mortgage renewals and refinancing to prepayments and finding the best mortgage rate for your situation, a mortgage broker is your secret weapon for achieving your goals.
They are an ideal resource for implementing strategies tailored to your personal and financial situation. Once you’ve established your priorities, your broker will use their access to a wide range of lending products to find the best rate and most advantageous loan conditions for your needs.
Already have a mortgage and thinking of accelerating your payments? A broker can analyze your contract and help you assess the impact of making a prepayment, or help you determine whether you’re better off paying a penalty to save on interest over the next term.
Key takeaways:
- Increasing the amount or frequency of your payments can save you thousands of dollars in interest and shorten the duration of your loan.
- Check the limits set by the lender in your mortgage contract to avoid prepayment penalties.
- Your mortgage broker can help you calculate the impact of prepayments and penalties, and help you save on interest costs.