In a perfect world, paying down your mortgage as quickly as possible is the ideal route for any homeowner. All this means is that you’re making larger payments toward your mortgage in a quicker time frame. Doing this can save you money on interest over the long-term, give you financial stabilityand also allow you to put more money toward savings. Given that everyone’s financial situation is different, this will determine the ways in which you can move forward and how fast you can reach the goal of being mortgage-free.
How can you pay down your mortgage faster?
If paying down your mortgage faster is an important goal for you, there’s a few ways you can go about this:
1) Monthly Pre-Payments
This is when you increase your monthly mortgage payment by a percentage to pay down your principal more quickly. Many people do this when they get a pay raise, a job bonus or even when they move in with a significant other. Some lenders will allow you to double up your monthly payments (100%), while others may allow you to make a 10% or 20% increase to your monthly payment. Depending on the type of mortgage product you have will depend on how much you can increase your monthly payments. Making monthly pre-payments will not only help you reduce the total amount of interest you pay over the life of your mortgage, but it also allows you to pay off your mortgage quicker than your original payment schedule. For some individuals, increasing your monthly payment by a percentage on a monthly basis may be easier to manage and budget for, compared to making a lump sum payment at the end of the year.
2) Annual Pre-Payments
These are lump sums payments that you can make on an annual basis to pay off your mortgage faster. These payments will apply directly to the outstanding balance of your mortgage. Some lenders allow you to pay 20%, some 15% and others 10%. Every mortgage has pre-payment privileges that limit how much you can pay down in a year. When shopping for a mortgage, it’s important to know what this number is if you ever plan on making annual payments. Further, it is a way to lower your penalty if you ever have to sell your home early.
Example:
Cindy and John have a $500,000 mortgage with a 25-year amortization period at a rate of 2.5%. They are 6 years into their mortgage and Cindy just got a pay raise. The couple decides that they will be paying down their mortgage an extra 2% this year. This will result in a lump sum payment of $10,000 for the year ($500,000 x 0.02). With 19 years left on their mortgage (25 years - 6 years), this additional payment of $10,000 will result in interest savings of $4,750 (0.025 x 10,000 x 19).
3) Accelerated Payments
An accelerated payment is different from a conventional payment in that it doesn’t average payments into the 12 months of a year. As an example, an accelerated bi-weekly payment is calculated by dividing your monthly payment in two, with 26 payments for the year. A conventional bi-weekly payment includes only 24 payments for the year. More payments per year allows you to pay down the principal of your mortgage more quickly, resulting in less interest paid and thousands of dollars saved. Homeowners also have the option of making accelerated payments on a weekly basis. As mentioned, this is a great feature for a borrower that expects their yearly salary or household income to increase, as it enables them to pay down their mortgage faster.
Why should you do this?
At the end of the day, the interest you pay on your mortgage is a lot of money added to your principal. For that reason, paying down your mortgage early can save you a lot of money in the long term by reducing interest payments and adding thousands of dollars in your pocket.
Making larger payments to your mortgage over the short term also provides financial security and stability for the future. For example, let’s say you have a $600,000 condo and you make a downpayment of $200,000. The amount you will need to borrow is $400,000 at a 2.5% interest rate. Making larger payments is basically like getting back 10%+ if you were to invest the original $100,000.The prospect of being mortgage-free also gives you the opportunity to allocate more money into retirement and personal savings, investments and even travel.
When not to pay off your mortgage faster
We recognize that there may be some instances where paying off your mortgage early may not be the right solution. For example, we don’t advise putting all of your income into your mortgage. Instead, take a closer look at your monthly income and expenses,and identify a realistic amount you can pay toward your mortgage that will also allow you to live comfortably.
When it comes to your mortgage, Homewise is committed to setting everyone up for success from the start. Working with over 30 banks and lenders, we help you find the best mortgage based on your unique circumstances. If you’re looking to make changes to your mortgage, apply online in just minutes and a Homewise Mortgage Advisor will get in touch and guide you every step of the way.
