Are You Taking Advantage of Your Mortgage Prepayment Privileges?

mortgage

By RateHub.ca

With the March 1st RRSP deadline fast approaching, mortgage prepayment privileges are probably the last thing on your mind. For many families, it’s all or nothing when it comes to RRSPs and mortgages – they either choose to increase payments on their mortgage or save for retirement, not both. But with a balanced approach, you can do both. Far too many people aren’t taking advantage of their mortgage prepayment privileges – according to the Canadian Association of Accredited Mortgage Professionals (CAAMP), only a third of homeowners made additional payments last year. Let’s take a look at the three most common prepayment privileges and how you can benefit from them.

1. Payment Increase

Once a year, most closed mortgages will give you the flexibility to increase your mortgage payment amount. You can usually increase your payment by up to 10 per cent or 15 per cent. While your regular mortgage payments go towards principal and interest, your payment increase will go directly to principal – this can shave years off the life of your mortgage. For example, if your monthly mortgage was $1,000, increasing your payment by 15 per cent means you could contribute an extra $150 per month towards the principal of your mortgage.

2. Lump Sum Payment

For a number of homeowners, lump sum payments are what first come to mind when they hear “prepayment privileges”. Lenders typically allow you to pay 10 per cent to 20 per cent of your outstanding mortgage each year. For example, if you have a mortgage of $200,000, a 20 per cent lump sum payment would be $40,000. That may sound like a hefty amount, but if you are saving for it or come into the money some other way, it is an excellent way to save on interest and cut time off your total amortization period.

3. Increase Payment Frequency

Your mortgage is most likely the largest debt you will ever have. By increasing your payment frequency, you can save thousands in interest simply by paying the same amount more often. With accelerated payments, you can pay your mortgage even faster, because you end up making extra payments than you would if you were making your regular monthly mortgage payments. For example, if your monthly mortgage payment was $1,600, an accelerated bi-weekly payment would divide that amount in half ($800) and you would pay that amount every two weeks – in this example, you would make 26 payments versus 24 regular bi-weekly payments, or an extra $1,600 each year.

RRSP Contribution vs. Mortgage Prepayment

Even if your budget is tight, you can still make RRSP contributions as well as consider your mortgage prepayment options. By making an RRSP contribution, you could then use a portion or all of your tax tax rate of 31 per cent, you’ll receive a refund of $930, which can be made as a lump sum payment towards your mortgage. Mortgage rates aren’t going to be low forever, so take advantage of them now and pay down your mortgage aggressively while you can.refund as a lump sum payment. For example, if you make a $3,000 RRSP contribution with a marginal

Comments

  1. I don’t prepay my mortgage because the interest rate is so low it doesn’t make sense to lock money in equity to save 3 to 5 percent interest. After you take long term inflation and the mortgage tax deduction into account (if you take it) the loan is almost free at today’s rates.
    Lance @ Money Life and More recently posted..What to Do If You Are A Victim of Identity TheftMy Profile

  2. I haven’t done this yet, but I like the idea, especially when I play with an amortization table showing how much interest I can save this way. But, as Lance said, the rate is pretty low, so instead I doubled my 401k investment, because it also has a 35% match guarantee!
    Jacob @ iHeartBudgets recently posted..Challenging Budget Exercise for a High School ClassMy Profile

  3. When we bought our first house, my husband and I took full advantage of our mortgage prepayment options by doubling up our payments frequently, and by putting down a lump sum towards our principal. It helped a lot. When we sold our house, we were able to keep a lot more of the funds and it felt really good to buckle down and put money towards our home.
    Pam recently posted..5 Tips For Negotiating The Cost Of A New CarMy Profile

  4. Although the mortgage rules seem to be a little bit different here in the states, we definitely are big fans of prepaying our mortgage. We hope to have ours knocked out in the next 2 years…then it is debt freedom baby!
    Greg@ClubThrifty recently posted..Majestic Colonial Punta Cana: A ReviewMy Profile

  5. It’s always interesting to see how things like this differ between the States and Canada. We’re not terribly active in trying to knock out our mortgage as it’s our only debt and the rate is pretty low. We do, however, generally try and make at least one extra payment per year or even two. That does shave years off of the mortgage without trying to pay it out in five years or something.
    John S @ Frugal Rules recently posted..5 Investing Mistakes That Are Easy to MakeMy Profile

  6. I put an extra $417 a month or $5k per year on the mortgage. We’re one of those couples that will pay off the mortgage early even though the rates are low. The one thing we know for sure is that in the 5 year term our rate won’t change. Anything after that is as good as a guess, same goes with investing. Anything could happen. It’s personal, and if others want to wag and smile because they are doing something different, more power to them. This is what’s right for us. We’ll save the cash from the mortgage to invest more in our retirement and save to renovate and who knows from there.
    Canadianbudgetbinder recently posted..The Grocery Game Challenge #9 Feb 25-Mar 3,2013-No-Shop Week, No Means No!My Profile

  7. I am a big proponent of prepaying on a mortgage – up to a point. A while back I did a worksheet on this where I found an interesting conclusion: your lifetime savings in interest payments goes up by more than a dollar per dollar of prepayment… until your principal payment equals your interest payment. In other words (ignoring time value of money effects) prepayment pays more in savings for a while, but then reverses once your mortgage payment parts (principal and interest) are in equilibrium. Thought your readers might be interested in that.
    JP Smith recently posted..Saving Money on VacationMy Profile

  8. It would be nice if we are all mortgage free in a few short years. With house prices sky high, it’s going to be tough. The strategies listed in this article are right on the money! Although it can be very difficult to see any progress, especially when you putting in small amounts compared to a huge mortgage, but over time, you could be shaving 5-10 years of your amortization. Doing small things above add up! Thanks for the post. Cheers -Pat
    Pat Drummond recently posted..Why it is Worth Paying for Online Access to your Credit ReportMy Profile