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Your home is likely the most valuable asset you own, but it’s probably tied to the biggest debt on the books. Out of all the monthly expenses you have to pay, your mortgage payments are probably the highest. Given this, it might be worth it to make every effort to pay off your mortgage earlier than its original due date.
But that may not always be the best course to take. Sinking all your money into your home might leave you with little available to do other things with, like investing.
So, should you pay your mortgage off early? Or should you leave your extra money to be put towards other expenses or investments?
How To Pay Off Your Mortgage Early In Canada
The first few years of your mortgage term can be quite depressing as most of the money you’re paying is going toward interest and not toward building equity. This will of course change as the years go on, but if you’re interested in building your equity faster, there are a few things you can do.
Accelerated Payment Option
The average homeowner typically makes monthly mortgage payments, so 12 payments in a year. This means that if your mortgage payment is $1,500 you’re paying $18,000 toward your mortgage every year.
This is where the accelerated payment option can help you shave years off your mortgage term. The accelerated payment option allows you to make half-payments (so in the case of our example, $750) every two weeks. One full year can be broken up into 26 two-week periods; this means you’ll make 26 $750 mortgage payments in one year which equals $19,500.
There you go, you can accelerate your mortgage payments by $1500 every year and you’ll barely even notice it.
Consider Lump Sum Payments
A mortgage is a long-term commitment, typically 25-30 years. This means that smaller extra payments really do add up in the long run. This is great for you because it means you can add an extra $100 here and there over the course of 30 years or you can devote bonuses or income tax refunds to paying off your mortgage quicker.
Let’s say on average you’ll be able to find an “extra” $500 a year for the entire duration of your mortgage, that’s an extra $15,000 you can put toward your paying off your mortgage. By doing this you will reduce your amortization period by years.
Speak With Your Mortgage Lender
Set up a meeting with your lender to speak with them about your options. There may be a payment option you had not considered or some type of restriction, it’s always in your best interest to speak with a professional.
Break It Down And Get Serious
Since paying off your mortgage faster is completely up to you and your financial decisions, it’s always a good idea to find motivation from somewhere. It could be from anywhere, but typically we find that seeing the numbers laid out in front of you is one of the best motivators. Here’s a breakdown of how quickly you’ll be able to pay off your mortgage when taking into account the above tips.
The example we’re going to use is a $350, 000 mortgage with a 30 year amortization period.
- First, you’ll switch to an accelerated payment plan, this means bi-weekly payments.
- Let’s say you’re able to find $5,000 in “extra” money every year (income tax refunds etc.)
- Another $1,000 a year from salary increases
- A $100 increase on each bi-weekly payment
- And finally any other cash you’re able to find throughout the year, let’s call it an even $1,000
In total that’s an extra $10,600 for extra payments every single year. If this isn’t enough motivation to get serious then we don’t know what is. While we do understand that the process of finding an extra $10,600 a year would be very hard, if paying off your mortgage as soon as possible is important to you, we know you’ll find a way to do it.
Pros Of Paying Off Your Mortgage Early
When it comes to paying off your mortgage early, there are several advantages you should consider.
You’ll Be Debt Free Sooner
Paying your mortgage off early means eliminating that hefty mortgage payment you work so hard to pay every month. This effectively makes you mortgage-free. And if that’s your only debt, you would effectively be debt-free, too.
No More Interest
Even if you have a great interest rate, the cost of interest over the course of your mortgage is big. The sooner you pay off your mortgage, the less money you’ll pay in interest.
To give you an idea of how much you can save, consider the following example. Let’s say you currently hold a mortgage of $400,000 at an interest rate of 4%. Your mortgage rate is fixed for 25 years and you are locked in for a 5-year term. The interest you would pay over the term and the entire amortization would be as follows:
- Term: $74,460
- Amortization: $231,224
As you can see, you could potentially save hundreds of thousands of dollars over the life of your loan if you pay your mortgage off much earlier than when it’s due in full.
Lower Expenses In Retirement
With no mortgage to have to pay in your golden years, you can enjoy having more money readily available in your retirement.
The more money you put into your home, the more equity you’ll accumulate. You can use that home equity at some point if you ever need a large sum of money to cover the cost of a major expense, such as a home renovation, college tuition for an adult child, or another investment.
By taking out a home equity loan or home equity line of credit (HELOC), you can borrow against your home rather than take out a personal loan, the former of which is easier to get approved for with more favourable terms.
No Mortgage Default Insurance
If the down payment you make when you take out a mortgage is less than 20% of the purchase price of the home, you’ll be required to pay mortgage default insurance — also known as CMHC insurance — on top of your mortgage payments. You can either pay this premium upfront or roll it into your mortgage, which most buyers do.
You won’t be able to cancel this insurance until the mortgage has been paid off. However, you may be able to lower or eliminate these premiums if you move into another home thanks to the “portability option.”
Learn About Accessing Home Equity With Mortgage Broker Dave Johnson
Cons Of Paying Off Your Mortgage Early
In addition to the perks of paying your mortgage off early, there are a few drawbacks that should also be considered.
Your Money Is Tied Up In Your Home
Sinking all your money into your mortgage may help you become mortgage-free sooner, but it could also mean that you’ll have less left over to invest elsewhere.
You May Be Able To Earn More By Investing
This depends on the interest rate of your mortgage compared to the earning rate of an investment vehicle. But, you could be losing out on better returns if you had used any extra money investing somewhere else rather than using it to pay off your mortgage.
Your Retirement Savings May Be Affected
If you’re not investing enough money in your RRSP or other retirement savings and putting all your cash toward your mortgage, you may end up house poor.
A Mortgage Is A Low-Cash Savings Tactic
Putting money into your mortgage can be viewed as a form of forced savings. But there may be other avenues to take to save and grow your money. Plus, tying up your money will leave you with little liquid cash that you may need in the time of an emergency.
You May Have To Pay A Prepayment Penalty
If you have a closed mortgage, you may be charged an early repayment penalty when you pay off your mortgage earlier than the original amortization period. You’ll want to find out if this fee applies in your situation, and if so, how much you would be charged.
Should You Pay Off Your Mortgage Early?
Everyone’s situation is different, so the right answer for you will not be the same for someone else. To help you determine whether or not you should pay off your mortgage early, consider asking yourself the following questions:
Do You Have Other Debts To Pay?
Consider all other debts that you are already paying down. Some may have a much higher loan amount than others. Even more importantly, some debts may come with higher interest rates than others.
Generally speaking, it’s best to focus on high-interest debt first. This is known as the “avalanche debt method” that involves paying down debts that have the highest interest rate. With this method, you can usually save the most money because you’re essentially getting rid of high-interest debt as quickly as possible.
The longer you hold onto debt that has a high-interest rate attached to it, the easier that interest will continue to accrue, which means you’re paying more than you have to.
How Will This Affect Your Retirement Savings?
There are certain important things that you may want to save up for, and your retirement fund is one of them. You want to make sure that you’ll be able to live comfortably after you stop working. And while you may be paid a little from the government after all those years of contributing to the Canada Pension Plan (CPP), you may want to top that up to accommodate your lifestyle.
So, consider how paying down your mortgage early may impact your retirement savings. Will all of your savings and income be going toward your mortgage, leaving you with little to contribute to your retirement fund?
Why Do You Want To Pay Off Your Mortgage Early?
Think about why you want to pay your mortgage off early. What is the exact reason, if you have one? Are you paying off your mortgage early so you can boost your cash flow every month? If so, you’ll want to have an idea of how those extra funds will be used.
Do you want to invest? If that’s the case, make sure that whatever money you would otherwise be spending on your mortgage is going into a sound investment. At the end of the day, it’s up to you how you choose to spend extra money that once went to mortgage payments.
Paying Off Your Mortgage Early vs. Investing The Extra Money
Eliminating your mortgage early means getting rid of your monthly payments, which of course will save you a lot of money. But doing so also means that all of your capital will be tied up in your house. Depending on your income, you may continue to earn enough to have plenty left over to invest elsewhere. If not, however, you may be missing out on other investment opportunities.
Have A Plan For The Money
Be sure to calculate how much money you can earn from a particular investment and compare that to the amount of money you could be saving by paying off your mortgage early.
If the earnings on another investment are higher than your mortgage interest savings, then it would be worth it to invest and continue paying a mortgage. But if the earnings from another investment break even with your mortgage interest savings — or are less than what you’d save if you paid off your mortgage — then you may want to put any extra funds into the home loan.
Compare your mortgage interest rate to the rate of return (after taxes) on an investment with a similar term. If your mortgage will cost less than what you would earn, perhaps keeping your mortgage is best.
Need More Information About Mortgages In Canada?
If you’re looking for a mortgage, let Loans Canada help connect you with a mortgage lender who can offer you the terms that best work for your situation.
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
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