Posted by: Vince Gaetano
There was a point when variable products had a lower discount off prime that provided a significant opportunity to implement a sound plan to reducing your mortgage over the term. Today, there is not much of spread between the variable and the fixed rate mortgage that would result in a difference.
Having said this, the key is not the interest rate you are pay but rather the payment amount you are making. Over the years, we have been advising MonsterMortgage.ca clients to base their payments on what they are comfortable paying and to not just make the minimum payment the lender is requiring you to pay.
Increasing your payment early on has a dramatic effect on reducing the amount of time you will have a mortgage. Increasing a monthly mortgage payment from $1,000 to $1,200 can save over 8 years of payments. You will be debt free 8 years sooner which means you will not have to make 8 years worth of monthly payments…this should motivate every mortgage holder in Canada.
The important aspect of bi-weekly payments is that you must have an accelerated bi-weekly payment for any benefit. In order to pay the mortgage faster, there has to be an accelerant that allows the repayment of the mortgage; splitting the monthly mortgage in half and paying every two weeks allows for a thirteenth month to squeeze into the aggregate annual payments.
By paying a half payment every two weeks, you are making 26 half payments that equal 13 full payments….the thirteenth payment is the accelerant that allows you to pay the mortgage faster. Bi-monthly payments DO NOT work nor do bi-weekly non-accelerated payments. Be careful and make sure you are on an accelerated payment frequency….if you are not, you will find out too late when your term is up and five years will pass with no benefit.
Most Canadians get a nominal raise every year and so should your mortgage payment. The majority of mortgages have payment increase privileges that should be taken advantage of. These increases can be from 10% to 100% depending on the mortgage lender and product. An increase to your mortgage payment of $25 to $30 dollars will result in significant time taken off your mortgage repayment.
Be aware of your mortgage privileges and be disciplined in your approach to paying off your mortgage faster. Lower interest rates have prompted many Canadians to buy more house and in some cases allowed some Canadians to skip over the entry level home and go straight to that move up home with extra bedrooms and space. The problem is that the extra bedrooms and space result in extra property taxes and increased costs in utilities and maintenance. One should make sure that the added costs outweigh the expenses of moving up from a starter home to a larger property.
Depending on your monthly payment and amortization, it can be a significant amount of savings. Over the course of 20-25 years, the interest on $2,000 will be over $300.00 (at 3.29%). So, if your monthly payment is $1,000 per month; you can chop off two months from your remaining amortization and over $300.00 in interest costs. The aggregate interest cost on the $2,000 over the amortization is over 15% during the 20-25 years! The reality is people need to better understand how amortization schedules can work to their benefit.
People need to understand how long term debt works and how to set a plan to control the debt regardless of where interest rates are today or where they are headed tomorrow. The most amount of interest is paid when the mortgage balance is at its highest.
Canadians have a significant opportunity today with interest rates at all time lows – we can accelerate repayment of the principal portion of our mortgages without the burden of high interest costs. For example, if we have a $200,000 mortgage with an interest rate of 4% for 5 years, our interest cost would be approximately $8,000 per year.
It is during this first term (5 years) that a homeowner needs to accelerate the repayment of the mortgage as quickly as possible. If rates double and increase to 8%, most would panic but if the homeowner only owes $120,000 after 5 years, the interest costs would only be approximately $9,600 per annum. The key point here is “regardless of where interest rates go, if you owe significantly less, it won’t matter as much”. Our philosophy to our clients that worry about rates has always been the same – “if you pay your mortgage down to half of what you owe before interest rates double, you will be paying the same amount of interest as when you owed twice as much.”
The variables people should consider are the prepayment privileges that lenders provide mortgage holders. These important mortgage clauses in the mortgage contract often get ignored and happen to be the key to getting to a zero balance faster than your neighbour. Be aware, be disciplined and be smart!