Mortgage vs. HELOC
All mortgages with the exception of open mortgages have certain mortgage prepayment restrictions. These restrictions prevent the borrower from paying off the mortgage, refinancing or renegotiating the mortgage terms prior to the end of the term (can still be done however with a penalty). This helps lenders manage their cash flow expectations from mortgages that they advance to their clients. Mortgages that have prepayment restrictions are called closed mortgages (see Open vs. Closed Mortgages for a detailed discussion of the differences between the two mortgage types). Not abiding by these restrictions (i.e. paying off the mortgage ahead of maturity) could result in the borrower incurring significant mortgage prepayment penalties.
However even close mortgages have certain mortgage prepayment privileges. These privileges allow the borrower to contribute more than regular payment to the mortgage and usually come in two forms:
Lenders generally allow borrowers to increase their regular monthly payment by a certain percentage. The allowed increase can be up to 100%, meaning if the monthly payment is $1,000 the borrower would be able to increase it up to $2,000. Doing so would result in the mortgage being paid off faster and the borrower saving in total interest costs.
If you’ve suddenly had an influx of cash and would like to pay off a part of your mortgage you normally can up to a certain limit. Doing so will help you pay off your mortgager quicker and could save you thousands of dollars in interest costs. The lump sum payment privilege allows the borrower to make additional payments on their mortgage in a given year. The limit can be up to 25% of the mortgage balance. Payments can be either made sporadically throughout the year or as one lump sum payment. Every year an additional 25% lump sum payment is permitted. However every year the lump sum payment limit gets smaller in size since the mortgage balance decreases. Going above the limit could result in mortgage prepayment penalties being incurred by the borrower.
Considering pre-paying your mortgage and wondering if there would be a mortgage prepayment penalty applicable? Use the Rates.ca Mortgage Penalty Calculator to find out!
If you’ve managed to save some money, got a raise, won the lottery, or experienced a positive change in your financial position through other means you mind consider taking advantage of the mortgage prepayment options discussed above. However before doing so you have to ask yourself the question – Is my money better spent somewhere else? To answer this question you need to examine that interest rate you’re paying on your mortgage and the other options for your money. For example if your mortgage rate is 3% and you have a credit card balance with a rate of 20% you’re better off using the money to pay off your credit card. Also if you believe that you can earn more than 3% by investing your money elsewhere than once again you’re probably better off doing so. The higher the interest rate on your mortgage the more it makes sense to use the access money to pre-pay the mortgage.