Christian finance and consumer credit counseling & debt management
After You Have Applied for a Mortgage
How to Pay Your Mortgage Off Faster
Any additional payment you make on your mortgage (also called pre-payment) will save you a lot of money in interest. Every normal payment you make consists of principal and interest. The interest portion of your payment is determined by the outstanding balance of your mortgage. As the outstanding balance diminishes, less of your payment goes towards interest and more comes off the balance.
Example – Principal vs. Interest
Mortgage balance
Rate
If the payment is
=
Amount applied to principal
+
Amount applied to interest
$150,000
6.45%
$1,000
=
$205
+
$795
$100,000
6.45%
$1,000
=
$465
+
$535
$50,000
6.45%
$1,000
=
$730
+
$270
The faster you reduce the outstanding balance on your mortgage, the more you will save in interest charges. Since pre-payment policies vary between institutions and types of mortgages, you should consult your mortgage agreement to fully understand the pre-payment options that may be available to you. Some ways to minimize your mortgage costs are:
A good way to shorten your amortization may be to choose the accelerated bi-weekly payment option. This allows you to pay half of your monthly payment every two weeks. By doing this, you end up making the equivalent of one extra monthly payment a year. To see how this works, see the following example:
Accelerated bi–weekly payment option
John pays $1,000 per month for his mortgage. Since he makes this payment 12 times a year, his payments total $12,000 at the end of the year.
Let's assume that John decides to make his payments every two weeks. His payments will be $500 every two weeks ($1,000 ÷ 2) and he will make 26 payments (52 weeks ÷ 2) for a total of $13,000 at the end of the year.
The following example illustrates how much you can save in interest charges if you choose the accelerated bi-weekly payment option, assuming your mortgage is $150,000, at 6.45 per cent, amortized over 25 years.
Example – Accelerated bi-weekly payment option
Monthly
Accelerated bi-weekly
Payment
$1,000
$500
Amortization
25 years
22.58 years
Interest paid
$150,059.80
$120,648.46
Interest saved
--
$ 29,411.34
Similar interest savings can also be obtained with the accelerated weekly payment option. If John decides to make his payments every week, his payment will be $250 every week ($1,000 ÷ 4). He will make 52 payments (52 weeks) for a total of $13,000 at the end of the year.
Keeping the same payments if you renew at lower rates
At the end of your term, when you renew or re-negotiate your mortgage, you may be able to obtain a lower interest rate, which will reduce your future payments.
An easy way to accelerate your mortgage payments is to maintain the same payments you were making during the previous term. The difference between your previous payments and your current (lower) payments will be applied to the principal, to reduce your mortgage balance and help you pay your mortgage down faster.
This is one of the easiest ways to pre-pay your mortgage, since it does not affect your budget and spending habits (you accelerate your mortgage payments, while continuing to make the payments you were accustomed to making during the previous term).
The following example shows how your new, lower interest rate allows you to make pre-payments of $200 per month, while keeping the same payment you had during the previous term.
Example – Keeping the same payments if you renew at lower rates
Difference - additional amount applied
directly to the principal to further reduce your mortgage balance
$0
$200
Increasing the amount of your payments
Most lending institutions will allow you to increase the amount of your mortgage payments. Some institutions allow an increase once a year; others, only once per term.
The amount of increase allowed varies by lending institution and by type of mortgage, and can be as high as 25 per cent.
For example: If your current mortgage payment is $1,000 per month, you may be able to increase it by $200 to $1,200 per month ($1,000 × 20% = $200). The extra portion of the payment is applied as principal against the outstanding balance of your mortgage and accelerates your mortgage repayment.
The disadvantage is that this increase may be permanent (depending on the lending institution), and it may be difficult to bring your payments back to their original amount. You should therefore make sure that you can handle new, higher payments until the end of your mortgage term.
Making lump-sum payments
Most lending institutions will allow you to make lump-sum payments against the principal. Since these amounts are applied to the principal only, they reduce the outstanding balance of your mortgage.
The amounts allowed vary by lending institution and by type of mortgage and can be up to 20 per cent, and sometimes more, of the original amount of your mortgage. If you borrowed $100,000 originally and your institution allows you to make lump-sum payments of up to 15 per cent, you will be allowed to pay up to $15,000 extra every year.
You can usually only do this once a year, and your institution generally determines when it can be done.
This pre-payment option is not cumulative. In other words, if you did not make additional payments on your mortgage this year, you will not be able to accumulate the percentage of pre-payment allowed and double your pre-payment next year. In the example provided, you would not be able to double your payment from $15,000 to $30,000, because you did not make a payment last year.
Paying extra on your payment dates
Most lenders will allow you to make additional payments on your mortgage, sometimes referred to as "double-up" payments. These extra amounts are applied to the principal only and reduce your mortgage balance, which helps you pay your mortgage off faster.
Although there are some limitations, which vary by institution and by type of mortgage, you can generally double your normal mortgage payment on any payment date. Some lenders may let you decide how much extra you want to pay (i.e., they may allow "partial doubling") and when you can pay it. Your lender might even agree to automatically withdraw the money for the extra payment from your account each payment date.
With double-up payments, the limits on your payment increases are not as strict as with the pre-payment option outlined earlier (100 per cent rather than up to 25 per cent), and you may stop making double payments at any time.
Some institutions, however, may deduct your total extra payments from the amount of the lump-sum payment you are allowed to make (see “Making lump-sum payments”, above).
For example, let's assume that your monthly payments on your original $100,000 mortgage are $1,000 and that you decide to make an extra $500 payment each payment date, and that your institution allows "partial doubling" of the payment amount. Let's also assume that your institution allows you to make lump-sum payments of 15 per cent of your original mortgage every year. Here is how some institutions will determine your maximum lump-sum amount for a given year.
Example – Maximum lump-sum payment allowed
Original mortgage amount
× 15% Minus:
Extra payments ($500 × 12)
Maximum lump-sum payment allowed
$100,000
$15,000
− $6,000
$9,000
When shopping around, it is important to ask the lender what the prepayment options and conditions are, so you can determine the best prepayment option for you.
Tips to minimize penalty charges
If you decide to break your mortgage to benefit from lower interest rates, you might be able to minimize the amount of penalty charges you have to pay. Keep in mind, however, that your lending institution may not offer this option. Look at your mortgage agreement to see what options are available to you or contact your branch.
Making a lump sum payment before renegotiating
As mentioned in the section "How to pay your mortgage faster", many mortgage agreements offer a pre-payment option without penalty, which may allow you to pay up to 20 per cent, and sometimes even more, of your mortgage off in any given year. If it is possible to do so, you may want to pay a portion of your mortgage (if your financial institution allows this) before you renegotiate it. Your penalty would then be calculated on the outstanding balance after you have made your pre-payment.
In the preceding example, if Jim had made a lump-sum payment of $5,000 before breaking his mortgage, his penalty would have been calculated on an outstanding balance of $92,218, instead of $97,218, and his penalty would have been $5,533, rather than $5,833.
Blend-and-extend option
Some institutions also allow you to extend the length of your mortgage prior to your mortgage renewal date, to take advantage of the current low rates by creating a new blended rate and longer-term mortgage. This is called the "blend-and-extend" early renewal option. Not all financial institutions offer this option, and different institutions have different ways of calculating this option. The following example gives you an idea of one common method of calculating the blend-and-extend option.
Example: Blend-and-extend option
Linda has 12 months left in her 60-month (five-year) mortgage, at
an interest rate of 8 per cent. Let's assume that the current five-year
mortgage rate is 6 per cent. If Linda decided to extend her mortgage
before its term ended and take on another five-year mortgage, her
new mortgage rate, using the blend-and-extend option, would be as
follows:
A + B
C
A is (8% x 12 remaining months in current term) = 0.96 B is (6% x 48 months of new term) = 2.88 C is 60 months (new term)
0.96 + 2.88
60
= 6.4%
If Linda chooses the blend-and-extend option, her mortgage rate
will be 6.4 per cent for the next 60 months, and she will not have
to pay a penalty to benefit from the lower rate. (Note:
Your financial institution may add an administrative fee.)
It may be beneficial for Linda to choose the blend-and-extend
option if she believes that interest rates will increase substantially
before the end of the term of her mortgage and wants to lock in
now.
The preceding method of calculating the blended rate has been
simplified for illustration purposes. The formulas used by financial
institutions are generally based on net present value; therefore,
your actual blended rate will be different (it is usually higher).
Contact your financial institution for the exact blended rate.
Things to remember when you switch institutions
A penalty may apply if you wish to switch institutions before the end of your mortgage term.
You may have to pay legal fees to discharge the old mortgage and register the new mortgage.
Other administration fees may also apply.
Don't hesitate to ask the lending institution whether it is willing to pay part or all of these fees.
If not, ask yourself if the savings of going to a new institution are greater than the cost of switching.
Your new prepayment privileges will not be based on the original amount of your mortgage, but on the amount of the mortgage balance transferred to the other financial institution.
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