Why Prepay your Mortgage?

January 14, 2013

Mortgage RatesIf you have some room in your budget and wish to be mortgage-free as soon as possible, you may want to consider mortgage prepayments. Not only will prepayments reduce the amount of time until you fully own your home, it could save your thousands, even tens of thousands of dollars in interest.

What is a Prepayment?

A mortgage prepayment is any dollar amount paid towards your mortgage that is over and above your standard amortized mortgage payment. The prepayment amount goes directly towards paying down your principal instead of splitting between your principal and interest, as with a standard mortgage payment.

Example: A mortgage of 25 years amortization at 5% mortgage rates on $250,000 principle results in a monthly payment of $1461 – any amount paid above this monthly payment would be considered a prepayment.

How Much can I Prepay?

The limitations on prepayments will depend on the terms of your mortgage, which are generally outlined on the front of your mortgage agreement. Some mortgages strictly limit or prohibit prepayments, while others may let you prepay as much as 25% of your mortgage amount per year. There are a few mortgage companies that will even let you double your monthly payment. You can usually choose to add the prepayment to your regular payment; you can also make lump-sum payments one or more times per year, or even use a combination of both prepayment options.

Why Make Prepayments?

Why should you make prepayments towards your mortgage? Two reasons: 1) it pays off your mortgage more quickly and 2) it can also significantly reduce the amount paid towards interest. By applying the prepayment directly towards your mortgage principle this amount has the ability to make a huge difference in paying down your mortgage.

Example: By adding $200 per month to the mortgage from the previous example, beginning at the end of the second year, there will be an interest savings over the entire mortgage of $36,775 resulting in a fully-paid mortgage 4 years and 7 months early.

Want to see how much you can save using prepayments? Use this calculator as a guide. Keep in mind that the actual savings may vary slightly depending on how your mortgage company calculates prepayments and interest.

What’s the Next Step?

If you are interested in setting up a prepayment with your mortgage company, check your mortgage agreement to confirm that prepayments are permitted, or contact your mortgage company for details and to arrange for payment by cheque or automatic bank withdrawal. For more information on prepayment and mortgage company regulations, consult the Financial Consumer Agency of Canada website.