December 18, 2012
Our language hides some spooky things; among them, the word “mortgage.” Did you know the term was derived from the French to mean “death-contract?” Yep, spooky indeed, but it doesn’t have to be that way.
Let’s ignore for a moment that most lenders don’t volunteer advice about how to pay off your mortgage sooner rather than later. The fact is, it is simply not in their interest to do so–yes that pun was intended.
Tip #1: Increase your monthly payments—even by a little
One of the best ways of making a dent on your mortgage statement is to increase the amount of your regular payments. Remember, it doesn’t have to be a significant chunk for the benefits to shine through.
- Chrissie is getting a mortgage of $150,000, amortized over 25 years, with a fixed interest rate of 5.45 % for 5 years.
- The lender tells Chrissie she must pay at least $911 a month.
- Chrissie is trying to decide if paying $50 more a month will help her save money.
- Assumptions: The interest rate of 5.45% remains the same over the 25-year mortgage.
Total Payment Over the life of the Mortgage
Monthly payment at $911 Monthly payment at $961 Principal $150,000 $150,000 Interest payments $123,368 $108,859 Total amount paid $273,368 $258,859 Interest savings
- $14,509 Years to pay off 25 22.5
By paying an extra $50 a month over the life of the mortgage, Chrissie could save over $14,000 and pay off the mortgage two and a half years sooner. As a side note, once you’ve decided to up-your-payments, you may not be allowed to lower them until the end of the term–be sure to check with your mortgage broker for payment terms.
Tip #2: If you renew at a lower rate, keep the same monthly payments you were making before
What if at the end of your mortgage term you’re able to obtain a lower interest rate? A lower rate will often translate into lower monthly payments right? Of course, what I suggest though, is that you take advantage of this situation by keeping the same monthly payments you were making before.
Why? This strategy will have the same effect as increasing your monthly payments—without your having to commit any additional out of pocket resources. Here’s an example of what I mean:
- Gilberto used to pay $1,000 each month on a $150,000 mortgage.
- When he renewed after five years, the interest rate had decreased by one percent, from 6.45% to 5.45%.
- While the lower interest rate would have reduced Gilberto’s monthly payments to $924,
- Gilberto decided to keep the monthly payment at $1,000 in order to reduce the total amount of interest he will pay over the term of the mortgage.
Keeping the same payments while renewing at lower interest rates
Monthly payments at $924 Monthly payments at $1,000 Principal $135,593 $135,593 Interest payments $86,228 $73,916 Total amount paid $221,821 $209,509 Interest savings
- $12,313 Years to pay off 20 17.5
Tip #3: Surrender to the charm of an accelerated payment option
While committing to the same mortgage amount each month, you can still save by choosing an accelerated payment option. With accelerated weekly and accelerated biweekly payments for example, you make the equivalent of one extra monthly payment per year. Over the life of your mortgage, this adds up and can save you thousands.
Not so with the default standard options offered such as monthly, semi-monthly, biweekly or weekly payments.
With these, there is no difference in the total amount paid over a year. At the end of the term, very little extra savings is achieved when switching from say a monthly payment option to a semi-monthly or bi-weekly option.
Tip #4: Take advantage of any Lump-sum prepayments offered
Lump-sum prepayments go directly towards attacking your outstanding principal. This strategy allows you to build equity faster and minimize overall interest paid. Some lenders will allow you to pay up-to-20% of the outstanding balance every year throughout the term.
How many folks do you know who can pay 20%of the mortgage annually? Very few perhaps. The trick is to contribute any percentage amount you can–think tax returns, bonuses at work, dividends from investments or an unexpected cash inflow. As long as your overall budget situation isn’t compromised by going this direction–you should be aggressive in this area.
Key things to remember
- Your mortgage agreement will specify whether you can make prepayments, when you can do so and other related terms or conditions.
- Go over it thoroughly, and ask your mortgage broker to explain anything you don’t understand.
- Your mortgage agreement may specify minimum and maximum amounts that you can prepay each year without paying a fee or penalty.
- The prepayment option is generally not cumulative. In other words, if you did not make a prepayment on your mortgage this year, you will not be able to double your prepayment next year.
- A closed mortgage agreement may require you to pay a penalty or fee for any prepayment.
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