Mortgage Prepayments vs Increasing Your Monthly Payments? The average new mortgage loan in Canada rose to exceed $300,000 for the first time while consumer debt hit $2 trillion. Yikes.
The faster you pay off your mortgage, the less you will pay in interest, reducing your overall loan cost. But is that the right choice for you? If so, should you up your monthly payments or choose lump sums?
Read on to learn all about mortgage prepayments to help you figure out what is right for you.
Mortgage Prepayments
Mortgage prepayments usually refer to money applied to the principal of the mortgage beyond the usual payments you make each month.
Every dollar you pay towards the mortgage early will lower the amount of interest you pay over the lifetime of the mortgage.
This is one way to pay down the entire mortgage faster. If you want to be mortgage-free sooner than the end of your amortization, mortgage prepayments are a great way to do it.
So how does this work? With prepayments, you would pay an extra sum whenever possible, whether that’s monthly, once a year, or sporadically.
Let’s say you get a $5000 tax refund, you might choose to apply it to your principal loan balance. Or you get a cash bonus or an inheritance.
Putting unexpected money into your mortgage principal is a great way to use those funds wisely. As you weren’t counting on that money, you won’t miss it once you put it onto your mortgage.
Increased Monthly Payments
Another way to prepay your mortgage is to pay more each month in addition to the payment you have to make.
Be sure to take careful inventory of your budget to see if you can afford to increase your payments each month. You don’t want to increase your mortgage payments only to find out that you can’t pay for your monthly expenses.
The great thing about committing to monthly payments (instead of lump sums) is that even small amounts can save you thousands over the term of the loan.
Even if you can only commit to an extra $25 or $50 each month, you are making a good dent in paying off your mortgage faster.
How Much Will You Save by Making Extra Payments?
When considering accelerating your mortgage payments, the first thing you need to consider is how much money you’ll save.
Let’s say you have a 30-year, $200,000 loan with a 3.5% interest rate.
Putting $3000 a year extra on your mortgage principal would save you over $40,000. Plus, the loan term gets cut down by almost a third. A lump sum of $3000 is the same as $250 a month.
Clearly, the savings can be huge even with small prepayments.
The best way to figure out the numbers is by using mortgage calculators to see your estimated savings. Then, compare that to the savings or returns you can get by investing the same money elsewhere.
Are There Restrictions on Prepaying Your Mortgage?
Both these options sound great in theory, but before you go any further, you need to double-check with your lender if mortgage prepayments are permitted.
Some mortgages allow you to prepay the loan however and whenever you want. Others, on the other hand, have stricter terms.
Some lenders make borrowers pay a penalty for prepaying their mortgage. This penalty could be a fixed amount or it might be a sliding scale percentage or something else entirely.
Some lenders allow you to pay a certain amount before the penalty kicks in. Penalities vary greatly from lender to lender.
You will need to read through your mortgage paperwork to figure out what you can and can’t do in terms of prepayments. Look for the section titled, “prepayment penalty disclosure” or “prepayment disclosure.”
Why Mortgage Prepayments Might Not Be Right for You
Paying extra on your mortgage can be helpful but it isn’t always the best use of your money.
As with any financial decision, you need to weigh the pros and cons of your unique financial situation.
Deciding to put more of your money into mortgage prepayments leaves you less liquidity for other expenses. If your monthly earnings are variable, prepayment could put you at risk of not being able to cover unexpected expenses.
If you have credit card or other high-interest debt, it makes sense for you to pay that down before making extra payments on your mortgage.
Another important question to ask yourself is, “Am I putting enough into my RRSP?” Do you have an emergency saving fund or RESP for your children. These are all things to consider for additional cash.
You might not know this but your mortgage interest payments could be providing you with tax savings. The value of your tax shield falls when your interest expenses go down.
Your tax accountant can tell you help the tax impact of prepaying your mortgage.
Also, if you are a savvy investor who is comfortable with some risk, then you might be better off investing those funds. It could yield a higher rate of return.
Finally, you could build wealth more efficiently long-term in other ways besides prepaying your mortgage. It is possible that inflation will accelerate over the next decade. If so, the real value of your mortgage liability would decline with the dollar.
Take Charge of Your Financial Situation
Thanks for reading our article! Â We hope this article has helped you figure out what may benefit you more: Mortgage Prepayments vs Increasing Your Monthly Payments?
At MBN, we offer mortgage solutions you can trust. Contact us today to discuss your mortgage needs. Call us for a free consultation at 1-877-383-1577 or simply apply online!
