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Should you pay off your mortgage faster?

10 December 2020 by National Bank
Should I Pay Off My Mortgage Early Or Invest?

Buying a property is often considered a good investment. For some homeowners, paying down a mortgage loan over 25 years is too long. Some people choose to pay it back more quickly. Are you wondering if this is the right option  for you? See our tips.

By paying off your mortgage faster, you'll save on interest and shave time off your loan duration.

Since a mortgage is usually the most significant debt you'll have in your life, paying it off also brings peace of mind and a sense of accomplishment.

Three ways to pay off your mortgage faster

There are many ways to pay off your mortgage loan faster. Here are the 3 main options:

Increase your payment frequency 

The frequency of your payments will impact how long you'll be paying back your mortgage. By making payments every 1 or 2 weeks, you'll repay the equivalent of one additional monthly payment every year. This means you'll pay your mortgage off more quickly. You'll pay back the borrowed principal faster and save on interest.

Make early payments

You can use an unexpected cash influx, such as a tax return, an inheritance or an annual bonus, to make an early payment on your mortgage.

During the same calendar year, you can prepay up to 10% of the principal amount borrowed without penalty. However, some fees may apply

With prepayments, you'll repay the principal faster and save on interest. 

Here's an example of how you can save on interest for a mortgage with fixed payments and interest rates throughout the amortization period:

Mortgage loan amount: $300,000

Fixed interest rate: 2.50%

Payment frequency: Monthly

  No prepayment
With a $30,000 prepayment after the 5th year
Interest paid $103,170 $85,598
Total of payments (principal and interest) $403,170 $385,598
Savings on interest $0 $17,572
Number of years to pay off the mortgage 25 years 22 years and 1 month

Make additional payments

With each payment of principal and interest, you can add up to 1 time the amount of your payment. That way, you can pay off your loan faster.

With these additional payments, you'll pay back the principal faster and save on interest.

Here's an illustration of an accelerated repayment using additional payments:

Mortgage loan amount: $300,000

Fixed interest rate: 2.50%

Payment amount: $1,343.90

Payment frequency: Monthly

  No additional payment
With an added $200 for each payment starting in the 6th year
Interest paid $103,170 $91,453
Total of payments (principal and interest) $403,170 $391,453
Savings on interest $0 $11,716
Number of years to pay off the mortgage 25 years 21 years and 10 months

 

In certain situations, you may have to pay fees when you accelerate your mortgage payments. For example, fees will apply if you renegotiate or repay your loan in full before the maturity date or repay more than 10% of the principal. 

Factors to consider before paying off your mortgage faster

Remember, if you pay off your mortgage faster, you'll have less money available for other things. That's why financial advisors recommend that homeowners verify they meet the following conditions before opting for accelerated payments:

  • You should have an emergency fund equivalent to at least 3 to 6 months of expenses to support yourself if the need arises. We advise against using this money to pay off your mortgage faster.
  • You have other types of savings.  
  • Don't let accelerating your mortgage payment affect your other financial goals (paying for your children's education, buying a second property, etc.).
  • Check that you don't have debt at a higher interest rate than your mortgage, such as a personal loan or credit card. You should pay off your debts with the highest interest rates first to save money.

Scenarios to help you decide

While the idea of being free of a large debt is attractive, rushing to pay down your mortgage as quickly as possible is not always the best strategy. 

You need to assess whether paying off your mortgage faster is the best option for you. 

For example, a self-employed person with a fluctuating income may decide to take advantage of a few profitable years to pay back their mortgage loan faster. This would ease their financial burden in the future.

A homeowner who is close to retiring may decide to pay off their mortgage loan faster while they're still working. When their income drops, they'll have fewer expenses. 

The faster an owner pays back their home, the sooner they can use their home equity for other projects, such as carrying out renovations or buying a rental property.

Take into account the state of the economy. For example, if mortgage interest rates are high and market returns are low, you should think about paying off your mortgage quickly. Conversely, if the market offers higher returns than interest rates on mortgages, investing could be a better option. Here's an example of an amount invested in a savings product compared with the same amount used to pay off a mortgage.

Monthly savings or additional payment amount: $250

Savings interest rate: 7%

Mortgage loan amount: $250,000

Fixed interest rate for the mortgage loan: 3.4%

Length: 15 years

  Savings of $250 Additional monthly payment of $250 on a mortgage loan
Interests $34,241 accumulated $11,304 saved
Principal $45,000 accumulated $45,000 paid back
Total $79,240 $11,304

 

Mortgage rates are currently at historic lows, so paying off your mortgage faster is probably not the best strategy. You wouldn't save much on interests and you would limit your saving capacity. Instead, you should take this opportunity to set up an emergency fund to deal with unexpected events and give you peace of mind. You could also invest in an RRSP or TFSA, to benefit from the advantages offered by these plans and finance another project. 

To help you make an informed choice based on your needs and financial situation, contact your mortgage advisor. They'll help you make the best decision for you.

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