Paying Off Mortgage Early
Buying a house debt free is impossible for most of us. However, there're effective ways to pay off your mortgage faster and save thousands of dollars on interest.
Make Extra Payments
Initially, most of a monthly payment is used to pay interest, and a small amount goes to a principal. Your payments will shift more towards the principal after few years. If you reduce the principal at the beginning of a mortgage cycle you will save money on interest.
Open mortgages can be pre-paid without a penalty, but they have higher interest rates than closed mortgages. If you want a closed mortgage look for a lender who will allow 10% - 20% pre-payments without a fee.
This is an example of how much you can save by paying $10 K at the beginning of the second year of a 5 year term, for a $200 K mortgage.
Your extra lump-sum payment will reduce the amount of interest over the life of the mortgage by $20,893, and you will pay off your loan more than 2 years earlier.
Choosing Pre-payment Options - Decide how much you can save for extra payments. You can usually obtain a closed mortgage at 1% less than an open mortgage, along with 10 to 20% pre-payment privileges.
There's no need to pay more in interest charges for an open mortgage if you're not sure that you'll be able to exceed this limit. You can always make bigger lump sum payments at a renewal time with no penalty.
Pay A Little Bit More
Let's consider the same mortgage as before. Instead of making lump-sum payments you increased regular payments from $1,163 to $1,200. Extra $37 a month over the life of the mortgage would save you almost $10 K and you could pay off the mortgage 17 months sooner.
Increase Payment Frequency
Accelerated weekly and accelerated bi-weekly payments result in big savings, as you can make equivelent of one extra monthly payment a year.
Semi-Monthy payments are made twice a month, on the 1st and the 15th, and you make 24 payments in the year.
Accelerated Bi-Weekly arrangement will let you make payments every two weeks (26 payments in a year) instead of paying twice in a month (24 payments in a year).
Accelerated Weekly payments are made once a week, the same way as regular weekly payments, and they both account for 52 payments in a year.
However, accelerated weekly payments are based on the assumption that there are exactly four weeks in every month, so they are slightly higher.
Examine closely the following mortgage payment frequency table. There's only a very small difference of 24 dollars between accelerated weekly and regular weekly payments.
Weekly payments of $267 save you almost nothing, whereas accelerated weekly payments of $291 leave in your pocket more than $25 K over the life of your mortgage, and cut short the amortization by more than 3.5 years.
Amortization is the number of years required to repay mortgage in full, typically 15, 20 or 25 years. When you apply for a mortgage the amortization time is assumed to calculate your payments.
This example shows how you can reduce the cost of borrowing with a shorter amortization.
Saving For A Down Payment
Save as much as you can. That's the first thing to begin with - the less you borrow the less you have to pay. These programs may help you to achieve that goal:
RRSP Withdrawal - First-time homebuyers may borrow up to $25 K (per person) from own RRSP under the Home Buyers' Plan.
Two years after the withdrawal, they must repay at least 1/15 of that amount every year over the next 15 years. The RRSP loan will be subject to income tax if it's not repaid within the allowed time limit.
Tax Free Savings Account (TFSA) - You can save up to $5 K every year, in addition to your RRSP. The unused part of your TFSA limit can be carried forward.
TFSA contributions aren't tax-deductible, but your gains won't be taxed and you can withdraw the money at any time.
Negotiate Mortgage Renewal
Don't accept right away your lender's offer to renew a mortgage at the end of a term. Rather think of it as a starting point from which to negotiate a lower rate.
Bargain with other lenders too. Switching to another one is quite simple. If you negotiated a lower rate for another term keep your payments at the same level - you already know you can afford them.