Paying Off Your Mortgage Early
Written by The Calgary Mortgages .CA Crew
Many of our clients ask for advice on how to pay off your mortgage early? The Real Question is… Should you?
As interest rates have moved down from 13% in the 1990’s to under 2% today, Canadian’s views on paying off their mortgage quickly have evolved.
Mortgage payments are are broken down into 2 pieces, the principal and the interest. When rates are high a HUGE portion of your monthly payment goes towards the interest and very little goes towards the principal. In this case, it’s a no brainer, pay off that mortgage as quickly as possible. When rates are low, like in today’s market, a huge portion of your monthly payment actually goes towards reducing the principal, so it’s harder to justify a quick mortgage pay down.
Paying off your Mortgage
Here is an example:
Purchase price of $400,000 with 5% down payment:
At an interest rate of 11%, over 5 years, only $20,666 in principal is reduced and the interest cost over those 5 years is $207,569.
At an interest rate of 1.64%, over 5 years, $66,684 in principal is reduced and the total interest paid is only $29,654.
What a massive change! How our parents managed their mortgages must be so different than what we think today.
Opportunity Cost
The term ‘Opportunity Cost’ is defined as the forgone benefit that would have been derived by an option not chosen. To properly evaluate opportunity costs, the costs and benefits of every option available must be considered and weighed against the others.
Sitting on cash? chequing accounts pay very little (sometimes zero) interest
If you were to expect that the $50,000 was going to sit in your chequing account for the next 5 years, it would make sense to put the money towards paying off the mortgage more quickly. The $50,000 would earn little to no interest in your bank account, thus the opportunity cost would be the $3,973 in interest savings on your loan.
Paying off your mortgage
- Lump sum pre payments. Any good mortgage should allow you to prepay at least 15% of the principal amount per year, you could make a large lump sum with a bonus, inheritance or your tax refund for example.
- Increasing your Monthly Payment – Most mortgage allow you to double your mortgage payment each month to reduce your principal more quickly. If your payment is $1,800, increase it to $2000, just that small increase will add up over the years.
- Increase your payment frequency. If you increase your payment frequency from monthly to accelerated biweekly, the extra payments you make will go directly to reducing your principal owing.
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