September 19, 2020

Hold your mortgage-burning party sooner

Long-term benefits; Accelerated payments on your home can save you thousands of dollars

By MARY TERESA BITTI, Postmedia News March 31, 2011

For most people, building up equity in their home is a good investment. According to the latest annual RBC Homeownership Study, not only are Canadians feeling overwhelmingly confident about the real estate market, 85 per cent are patting themselves on the back when it comes to paying down the mortgage.

“Canadians believe in the long-term benefits of owning a home and the value it can provide to overall wealth,” says Marcia Moffatt, vicepresident, home equity financing, Royal Bank of Canada. “And a significant majority of Canadian homeowners believe they are doing a good to excellent job of paying down the mortgage – the biggest debt they are likely to have. This speaks specifically to their ability to manage their mortgage debt.”

But is it enough to simply meet mortgage obligations, even if interest rates are at historic lows? For example, at the time of writing, CIBC offered a five-year fixed mortgage at 3.99 per cent and a variable rate mortgage at 2.85 per cent. The fact is, if you are early in your house-rich, cash-poor years, paying down your mortgage could save you tens of thousands of dollars.

In a typical conventional mortgage, the payments are a blend of principal and interest. The longer you take to pay off your mortgage, the more money you pay in interest as opposed to principal. “Generally speaking, at the start of your mortgage repayment, the weighting is towards paying the interest with a lower principal repayment,” says Barbara Garbens, a registered financial planner and president of B L Garbens Associates Inc. in Toronto. “It isn’t until towards the end of your mortgage that you are paying mostly principal.” Think of it as reverse compounding.

Think of your mortgage as a forced savings plan, says Garbens. “It builds wealth, and the sooner you pay it off, the more control you have over your bigger wealth portfolio.” If you are counting the days to that all-important mortgage-burning party here are several strategies to help you get there quicker.

— Shorten the amortization period. Consider the numbers. A $200,000 mortgage at five per cent amortized over 30 years with monthly payments will cost $384,268, of which $184,268 is interest. If that same mortgage is amortized over 25 years, the total cost is $348,963, of which $148,963 is interest. The total interest savings by shortening the amortization by five years is $35,305.

— Take advantage of pre-payment options. Many closed mortgages allow you to double up a payment or pay up to 10 per cent of your mortgage annually. “Prepayments are applied directly to the principal balance, saving thousands of dollars in interest costs over the life of the mortgage,” says Moffatt. “For instance, if you double up payments once per year for 20 years on a $250,000 mortgage at four per cent interest over a 25-year term, the amortization reduces to 22.1 years and saves you $20,612.86 over the life of the mortgage. If instead you add $100 to each payment over 20 years, the amortization becomes 22.3 years with a savings of $18,291.31 over the life of the mortgage.”

— Most Canadians are paid every two weeks. Align your mortgage payments to your paycheque deposit and make mortgage payments every two weeks instead of monthly. This allows you to make an extra payment each year – saving on interest costs. For example, “a 25-year $200,000 mortgage at five per cent with monthly payments will cost $148,963 in interest,” says Garbens. “If we change payment frequency to biweekly, then total interest paid is $124,786 – a savings of $24,177. And if you opt for a 20-year amortization period on a biweekly payment schedule, you save $30,000 in interest.”

— If you have opted for a variable rate mortgage, make the most of the low interest rates by setting the payments at the same levels as those required for a fiveyear fixed rate mortgage, suggests Colette Delaney, senior vice-president, mortgages, lending and insurance, CIBC Retail Markets. “This allows you to pay more towards the principal each month because you are accelerating payments.”

— Look to those one-time op-portunities to reduce your principal. “For example, if a bonus or tax refund is coming your way, use some or all of it to reduce your mortgage balance,” says Delaney.

— Use your investment port-folio to pay down your mortgage and reborrow to invest. “You’ll have the same loan level, but now those interest costs are tax-deductible,” says Garbens.

“A home is the most significant financial investment most of us will ever make,” says Delaney. “Our view is it deserves thought and attention up front, first to ensure you are getting the right mortgage for you, secondly that you are getting the flexibility to increase the payments down the road to pay your mortgage down faster. Doing this can give you years of peace of mind and help with your overall financial planning.”

© Copyright (c) The Montreal Gazette

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