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Mortgage Pre-Payment

Jamie David

Mortgage pre-payment options outline the flexibility you have to increase your monthly mortgage payments or pay off your mortgage as a whole without penalty. The monthly pre-payment provision is a percentage increase allowance on your original monthly mortgage payment, while the lump sum provision allows you to put money towards your mortgage principal. According to the Mortgage Professionals Canada's Annual State of the Residential Housing Market in Canada, 33% of Canadians took advantage of pre-payment privileges in 2020.

 

Popularity of mortgage pre-payment options

A lot can happen over a mortgage term that can affect your ability or desire to pay off your mortgage sooner than you had originally anticipated. You may gain access to cash flow you did not expect throughout the term of your mortgage, in the form of a salary increase, bonus or inheritance. Such cash flow influxes are not uncommon; therefore, you may want to consider putting this money towards your mortgage, as it will reduce the total amount of interest you will pay. Pre-payment options allow you to pay off a mortgage at a faster rate than the original payment schedule outlined by your lender.

In fact, the vast majority of Canadians have the ability to afford higher mortgage payments. In a survey conducted by CAAMP, 84% of respondents said they could handle monthly increases of $300 or more on their monthly payments.

In effect, 33% of mortgage holders did make additional payments on their mortgages in 2020. This includes 15% who increased their monthly payments, 17% who made lump sum payments, and 6% who increased the frequency of their payments1. Since many Canadians do take advantage of pre-payment options, it is important to compare pre-payment allowances across different lenders.

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Mortgage pre-payment tradeoffs

Making additional payments on your mortgage will reduce your amortization period and, thus, interest payable; however, it is important to consider the opportunity cost and alternative investment opportunities. For example, it may be possible to contribute to your RRSP and use the tax savings to then make a lesser contribution towards your mortgage, maximizing your return overall.

 

Additional mortgage acceleration mechanisms

Another way you can fast-track your mortgage is by switching your payments from monthly to weekly or accelerated bi-weekly. As the demand for such options has grown, more lending institutions are allowing them. Without penalty fees, more frequent payment options can take several years off your mortgage amortization.

For instance, say your monthly mortgage payment is $400. Your yearly outlay is $4,800 (400 X 12 months). By dividing the $400 by 4 weeks, you would have a weekly payment of $100, and, thus, now pay an annual amount of $5,200 (100 x 52 weeks). Similarly, by dividing the $400 by 2 you would have a bi-weekly payment of $200 and again pay an annual amount of $5,200 (200 x 26 bi-weekly pay periods). As illustrated, you can see that the more frequent payment methods result in an additional $400 ($5,200 - $4,800) applied to your mortgage each year, which directly reduces the principal. These accelerated payments can reduce a 25-year mortgage amortization to 21 years, reducing the interest period by four whole years.

For some, products that allow you to combine your mortgage debt with a current account, such as a chequing account, also present an attractive mortgage acceleration option. One such product is Manulife Bank's "Manulife One" account, which combines your mortgage debt and regular chequing account. Every deposit made to the account immediately reduces your mortgage debt while every withdrawal, naturally, increases it. The principle behind it is that by depositing your wage, you will receive the immediate benefit of reducing more of your mortgage interest expense than if you were to make a regular mortgage payment. This is an attractive after-tax alternative to leaving your wage in a low interest savings account where anything it earns is taxable. However, you must consider the large negative balance on your bank statement each month and the nearby temptation to draw money to the maximum of your available credit line. For those who have budgeting difficulties, this is not an appropriate mortgage product.

 

References and Notes

  1. Annual State of the Residential Mortgage Market in Canada, Mortgage Professionals Canada, 2021

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