Should you pay off your mortgage early?
Buying property is considered an excellent investment. However, for some homeowners, a 25-year amortization period is too long of a commitment. Many choose to repay their loan faster. Is this really a good strategy?
Accelerating the repayment of your mortgage is a delicate issue. While this often saves thousands of dollars in interest costs and shortens the loan term, doing so is only beneficial under certain conditions.
When is it not advantageous to repay your loan quickly?
Experts believe that, in most cases, paying off your mortgage before term is not a great idea. Here are a few situations that illustrate why:
- At retirement, when cash inflow is lower, someone who decides to pay off their mortgage more quickly could find themselves with cash flow problems sooner.
- An accelerated mortgage repayment also causes less budget flexibility. If income drops for any reason, the homeowner may have trouble meeting his financial obligations.
- If a person can contribute more to their RRSP, or if they are looking to accumulate capital for a major project (buying a chalet or starting a business), the pre-term mortgage repayment could limit their savings capacity.
- If a person saved $250 a month for 15 years at an interest rate of 7%, they would accumulate $78,215 ($45,000 in capital and $33,215 in accrued interest). On the other hand, if this same person had chosen to add an additional monthly payment of $250 for 15 years toward the repayment of a mortgage loan worth $250,000 (at an interest rate of 3.4%), they would have saved only $11,377.
A payment strategy for certain homeowners:
Financial advisors recommend that homeowners repay their mortgage more quickly if the following financial conditions are met:
- They have an emergency fund that would allow them to support themselves for a period of 6 to 12 months.
- They can rely on other savings and plan to live in their homes at least 5 to 10 years.
- The outstanding balance is minimal and accelerated repayment will not affect their other financial goals.
If these conditions are met, homeowners have several options for paying off their loan, such as an increase in payments or frequency of payments, or prepayments.
Increase in payments
Increasing your mortgage payments by as little as $20 a month saves money while reducing the mortgage term. For example, if someone adds only $75 to each monthly payment for a mortgage loan of $250,000 at an interest rate of 3.4%, they can repay the entire loan in 23 years instead of 25, and save $11,587 in interest charges.
Acceleration of payment frequency
Whether monthly, bi-weekly or weekly, the timing of payments also impacts the spread of mortgage payments. Paying $500 every two weeks, instead of $1,000 a month, totals 26 payments per year, which is an additional monthly payment.
Tax refunds, inheritance, or annual premiums are forms of income that can be used toward the repayment of the loan. Most mortgage agreements offer the option of making additional payments each year, but under certain conditions. These are negotiated at the time of signing the contract, and the sum is generally limited to 10% of the initial amount of the loan, without compensation.
At each payment, an additional payment may be made, provided the amount is equal to or less than the regular payment (taking into account principal and interest).
If you want to free up your mortgage payments earlier, it’s important to know about these different options. That being said, in order to choose the best solution for your needs and financial success, meeting with a bank advisor is highly recommended.
Edited on 10 July 2018