Buying real estate will undoubtedly be one of the most substantial investments you’ll make, due to its significant costs and the years spent repaying the loan from your financial institution.
In Quebec, mortgage loans, including those with mortgage insurance, can extend up to 25 years. While this offers benefits, some may find this period too long. As a result, many choose to accelerate their mortgage payments. Let’s see what that entails.
Why pay off your mortgage faster?
Accelerating mortgage repayment appeals to many homeowners for several reasons. One primary benefit is reducing the amount spent on interest charges, which can accumulate significantly over the loan's duration. By paying off the mortgage faster, whether by a few months or years, homeowners can save a substantial sum in the long run.
Additionally, early repayment shortens the overall term of the loan. This not only provides financial benefits but also offers a sense of security and accomplishment.
Watch out for mortgage penalty fees!
But beware, paying off your mortgage faster can come with its disadvantages. Depending on your agreement with your financial institution, you may be subject to a prepayment penalty.
What is a prepayment penalty?
A prepayment penalty, also referred to as a prepayment charge or termination fee, is a fee imposed by your lender in certain situations. These typically include:
- Terminating your mortgage contract early.
- Making extra payments beyond what is specified in your mortgage agreement.
- Transferring your mortgage to another lender.
- Selling your home before the end of the mortgage term.
Prepayment penalties are commonly associated with closed mortgages, while open mortgages generally permit prepayments without any penalties.
How to calculate prepayment penalties?
Calculating prepayment charges can vary depending on the lender and involves several key factors:
- The amount you intend to prepay
- The number of months remaining until the end of your mortgage term
- The current interest rate
- Your lender's specific calculation method.
Typically, the prepayment penalty is determined as the higher of two amounts:
- An amount equal to 3 months' interest on the outstanding balance.
- The interest rate differential (IRD), which reflects the difference between your contracted interest rate and the current rate for a term similar to the remaining term of your mortgage.
It's essential to carefully review your mortgage agreement to understand the indemnity charges applicable for early repayment.
Some financial institutions offer online calculators to help estimate prepayment fees, providing clarity when considering paying off your mortgage ahead of schedule.
Prepayment lien
In some cases, lenders may offer a prepayment option called a prepayment lien, which allows you to repay a specified additional amount beyond your regular mortgage payments without facing a penalty.
This privilege typically allows you to increase your payments by a certain percentage or make a lump-sum payment of a predetermined amount or percentage. Usually, this option is evaluated on an annual basis. It's recommended to consult with your lender to understand the exact terms and conditions that apply to your situation regarding the prepayment lien.
How can I pay off my mortgage sooner?
When your mortgage renewal approaches, it's a good time to thoroughly examine your contract and repayment terms. This evaluation provides an opportunity to discuss potential adjustments, with your financial institution, that better align with your current circumstances.
Prior to the renewal, it's beneficial to reach out to your mortgage broker to explore the various options that may be available to you.
1. Opt for a shorter amortization period
Opting for a shorter amortization period can be a strategic move when obtaining your first mortgage or considering a new one. Instead of committing to a 25-year repayment term, you might opt for a 20 or even 15-year term, depending on what your lender offers.
It's important to carefully assess your financial readiness for this decision, as shorter amortization periods typically require higher monthly payments. However, the benefit lies in significantly reducing the total interest paid over the life of the loan.
2. Increase the frequency of your payments
The frequency of your mortgage payments can significantly impact both the duration of your mortgage and the total interest paid. If you have a steady income, aligning your mortgage payments with your cash inflows can help you better manage your budget.
If your current mortgage requires monthly payments, transitioning to accelerated weekly or bi-weekly payments during the renewal can be advantageous. Accelerated payments enable you to effectively make an additional month's payment each year without increasing your monthly payment amount. This strategy can significantly shorten the time it takes to pay off your mortgage and reduce the overall interest amount.
3. Increase the amount of your payments
Increasing the amount you pay towards your mortgage, even by a few dollars, can significantly accelerate your repayment timeline in the long run. If your budget permits, consider allocating a slightly higher monthly sum towards your mortgage.
Before proceeding, it's crucial to review the terms of your mortgage contract. Some agreements may restrict the annual increase in payments, and exceeding this limit could lead to penalty fees.
Additionally, ensure that you can sustain the increased payment amount over the duration of your mortgage term, as financial institutions typically do not allow reductions in payments once they have been increased.
4. Make prepayments
Using occasional windfalls of cash, such as tax refunds, inheritances, or bonuses, to make early repayments on your mortgage can drastically speed up your repayment timeline. However, it's essential to carefully examine your mortgage contract beforehand, as there may be indemnity charges or penalties associated with early repayments, as mentioned previously.
The ability to make additional payments varies depending on the type of mortgage you have. An open mortgage generally offers more flexibility in this regard compared to a closed mortgage.
5. Lower your interest rate
When it comes time to renew your mortgage, securing a lower interest rate can significantly accelerate your loan repayment. By maintaining your current payment amount while benefiting from a reduced rate, more of your payment goes towards paying down the principal rather than interest.
The opportunity to lower your interest rate depends on prevailing market conditions at the time of renewal. It's wise to compare offers from different lenders to find the most favourable rate available.
However, if you decide to transfer your mortgage to a new financial institution to take advantage of a lower rate, it's important to consider potential costs such as registration, discharge, or administrative fees.
These expenses should be weighed against the savings gained from the lower interest rate to determine if switching lenders will be financially beneficial in the long run.
Is it worth it to pay off your mortgage early?
Deciding whether to pay off your mortgage early depends on several factors, such as your financial health, prevailing interest rates, and your personal goals and plans.
However attractive it may seem, prioritizing early mortgage repayment should not jeopardize your overall financial stability. It's essential to consider that funds allocated to accelerate mortgage payments could otherwise be used for different purposes.
Before deciding, make sure that:
- You have an emergency fund or adequate savings to cover several months' worth of expenses in case of unexpected needs.
- You have other forms of savings or investments in place that align with your financial goals.
- Accelerated mortgage repayment will not compromise your ability to pursue other important projects, such as funding your children's education or preparing for retirement.
- You do not have debts with higher interest rates than your mortgage, such as personal loans or credit card balances. If higher-rate debts exist, prioritizing repayment of these debts may be more advantageous than focusing on paying
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