Mortgages are considered “good” debt, at least according to consumer surveys. Yet, for most new homeowners, mortgages are a financial noose around the neck.
Home loans are bigger than ever, and their interest is non-tax deductible if not used to generate income.
Squashing one’s mortgage is therefore a lifetime ambition for many people. That’s why 1 in 3 mortgagors (1.9 million households) paid extra on their mortgage last year.
Unfortunately, prepayment plans are routinely dismissed like a well-intentioned New Year’s resolution.
Besides having to deal with unexpected expenses, one reason people give up on their mortgage prepayment plan is that they don’t have a clear goal to motivate them.
That’s why knowing when you’ll be mortgage-free is key to planning any prepayment strategy. Do you know what it would take to shave five, 10 or even 15 years off your mortgage?
Well, we’re about to tell you.
Let’s pretend you have a $100,000 mortgage.
Why $100,000? Because it lets you easily scale the results that follow. If your mortgage is $350,000, for example, you simply multiply the numbers below by 3.5 (since $350,000 is 3.5 times greater than $100,000).
In any case, here’s how much you’d have to prepay each year to have a $100,000 mortgage paid off by 2030, 2035, or 2040, using these sample interest rates:
Details: Results are rounded for simplicity. Assumptions include a $100,000 mortgage, constant rates over the amortization period, a 25-year amortization and prepayments made annually on the mortgage anniversary date. Calculated using Vancity’s Mortgage Calculator (link), one of the few accurate calculators that apply prepayments at the end of each mortgage year.
For an average mortgagor, shortening your mortgage by five years is not tremendously daunting, as this table shows. Lopping off 15 years is a totally different conversation.
Based on the average Canadian mortgage amount (about $282,000 according to TransUnion), a homeowner with a mortgage rate of 1.99% would have to pay an extra:
- $235 a month to retire their mortgage five years early (2040)
- $1,400 a month to retire their mortgage 15 years early (2030)
In other words, if you just bought a home, get used to having a mortgage for a while.
Should you prepay your mortgage?
That’s a personal finance decision, and one could write 1,000+ words on it. Suffice it to say, prepay your mortgage if that’s your best use of spare cash, keeping in mind that mortgage prepayments yield a practically risk-free and tax-free return (interest savings).
A prepayment on a 3% mortgage is like earning 5% in an unregistered account, assuming a 40% tax bracket.
Factor in liquidity too. You always want to be sure you have access to emergency cash if you’re tying up your money in a mortgage. Or, at least have a line of credit or readvanceable mortgage you can fall back on if you lose your income and need to borrow for emergencies, etc.
And sometimes it’s not about ROI (return on investment) at all. Sometimes knowing you have a paid-off mortgage and that no one can take your house is reason enough to strive for mortgage freedom sooner.
Ways to prepay your mortgage
There are multiple ways to supplement regular monthly mortgage payments:
1. Increase your monthly payments: Most lenders allow you to increase your monthly payments up to 10%, 15% or even 100% of the mortgage value. According to Mortgage Professionals Canada (MPC), 17% of mortgage holders increased their monthly payments in 2019.
2. Make annual lump-sum payments: If you don’t want to commit to higher monthly payments, you can also make one or more lump-sum payments each year. Again, most lenders allow you to prepay up to 10% to 30% of your original loan amount each year. Data shows 15% of mortgage holders made lump sum payments in 2019.
3. Accelerate your payments: Most financial institutions offer a variety of payment frequencies, including “accelerated weekly” and “accelerated bi-weekly” (both the equivalent of making one extra monthly payment each year). You can even time extra payments to coincide with your paycheque. The savings over the life of your mortgage can amount to tens of thousands of dollars and shave years off your amortization. About 6% of homeowners increased their payment frequency last year.
4. Make the same payments after renewal: When your mortgage comes up for renewal at the end of the term, you might score a better rate. If you do, that would lower your monthly payments other things equal. But if you keep your payments the same as when you had the higher rate, that extra money goes straight towards paying down the principal more quickly.
MPC’s survey found that nearly seven out of 10 mortgage holders (68%) took no action in the last year to pay down their mortgages faster than required.
Now that you know how easy it is to whittle down your principal, there’s less reason to be among that statistic.