Mortgage vs. HELOC
Prepayment restrictions are the fundamental difference between open and closed mortgages.
An open mortgage permits you to repay virtually any portion of the loan amount at any time, without penalty.
There’s no free lunch, however. Open mortgages tend to have higher interest rates thanks to their pre-payment flexibility.
Closed mortgages have strict prepayment limits, intended to deter borrowers from paying ahead of schedule.
When you pay a closed mortgage off ahead of maturity, it’s expensive for the lender so the penalties help them to reduce this risk.
Despite the restrictions on closed mortgages, they do allow some prepayment privileges. Here’s a quick overview:
For folks with an influx of cash who want to pay their mortgage faster, one way to do that is to make a lump sum payment. The annual limit for these payments is most commonly capped at 15 to 25 percent of the remaining principal balance. The entire amount goes towards your principal, lowering your ongoing interest costs almost immediately.
Most lenders allow borrowers to increase their regular scheduled payments by 20 to 100 percent without having to renegotiate the loan. Doing so results in the mortgage being paid off faster and with less interest.
If you’ve managed to save some money, got a raise, won the lottery, or experienced any other positive change in your financial position, you might be tempted to accelerate your mortgage payments.
Before doing so, ask yourself, “Is my money better spent elsewhere?”
To answer this question, people compare the interest rate they pay on their mortgage to the after-tax return they can earn by deploying their cash elsewhere.
For example if your mortgage rate is three percent and you have a credit card balance at 20 percent interest, paying down the credit card first is clearly beneficial. Or perhaps you believe that you can earn more than three percent by investing your money.
The higher the interest rate on your mortgage the more it makes sense to exercise your prepayment privileges and pay it down sooner.
Are you considering pre-paying your mortgage? Use the Rates.ca Mortgage Penalty Calculator to find out how much it will cost.