Paying your mortgage down faster

Every closed mortgage comes with permission to pay off more than the scheduled amount each year without penalty. These are your prepayment privileges, they are written into the contract, and a great many people never use them because nobody explained they existed.

They are worth understanding, because used properly they take years off a mortgage.

The three kinds

Most mortgages give you some version of all three.

Lump sum payments. You can pay a percentage of the original principal each year, penalty free. Commonly somewhere between ten and twenty percent depending on the lender, and note that it is a percentage of the original amount, not the current balance.

Payment increase. You can raise your regular payment by a set percentage, often ten to twenty percent, and the increase goes entirely to principal. Some lenders let you do this once a year, others any time, and some allow you to reverse it later if money gets tight.

Accelerated payment frequency. Switching to accelerated biweekly or accelerated weekly. This is the quiet one and it is explained below.

The exact percentages and the rules around them vary considerably between lenders. Check your commitment letter, or ask your lender directly.

Why a lump sum is worth more than it looks

A regular mortgage payment is split between interest and principal. Early in an amortization most of it is interest.

A prepayment is different. Every dollar goes to principal. Nothing is taken for interest.

That matters because the dollar you remove from the balance today stops accruing interest for the entire remaining life of the mortgage. Doing it in year two of a twenty five year amortization is dramatically more valuable than doing the same thing in year twenty. Prepayment is one of the few areas of personal finance where acting early genuinely compounds in your favour.

The accelerated trick

This is the easiest win available and it barely registers as a sacrifice.

A standard biweekly payment takes your annual total and divides it by twenty six. You pay the same amount over the year, just in smaller pieces.

An accelerated biweekly payment takes your monthly payment, halves it, and charges that every two weeks. Because there are twenty six two week periods in a year rather than twenty four, you end up making the equivalent of one extra monthly payment a year.

That single change, made at the start and then forgotten about, can take several years off a twenty five year amortization. Most people do not feel it, because the money leaves in step with their pay cycle.

If you are setting up a new mortgage and the cash flow works, take the accelerated option by default.

The rules that trip people up

It is a percentage of the original amount. Not the balance today. Most people assume the opposite and undershoot.

The allowance usually does not carry forward. Skip a year and that year’s room is gone. It does not accumulate.

Some lenders restrict when. A few only allow lump sums on payment anniversary dates or within specific windows. Others allow any time. This varies more than almost any other term, so check before you plan around it.

There may be a minimum. Some lenders will not accept a lump sum under a certain amount.

Exceeding the allowance triggers a penalty. Go over and the excess is treated as a partial break, priced the same way as breaking the mortgage.

Whether you should

Paying down a mortgage is not automatically the best use of spare money, and we would rather say so than pretend otherwise.

Clear higher cost debt first. Credit cards and unsecured loans cost far more than a mortgage. Paying down a mortgage while carrying a card balance is moving backwards. If several balances have built up, our debt consolidation page covers the alternative.

Keep an emergency fund. Money paid into a mortgage is not easily retrievable. Getting it back means refinancing or a line of credit, both of which take time and cost something. Do not put your last liquid savings into the house.

Compare against registered accounts. Depending on your marginal tax rate and what your investments return, contributing to an RRSP or a TFSA may do more for you. This is genuinely a case by case question and worth an accountant’s view rather than a rule of thumb.

Consider the certainty. Paying down a mortgage is a guaranteed, risk free return equal to your mortgage rate. Very little else is guaranteed. For people who value certainty, that has a worth the spreadsheet does not capture.

A use people miss

If you are about to break your mortgage, make your prepayment first.

The penalty is calculated on the balance outstanding. Reduce the balance with a penalty free lump sum, then break, and the penalty is calculated on the smaller figure. On a large mortgage with a significant interest rate differential this can save a meaningful amount for no cost at all.

It only works if you have the room available and the lender allows the sequence, so ask before you assume it.

How to actually do it

Most lenders let you make a lump sum through online banking, often under a mortgage payment option. Some still require a phone call. Payment increases and frequency changes usually need a request rather than a form.

Two things to confirm each time. That the payment was applied as a principal prepayment rather than being held as a prepaid regular payment, which is not the same thing. And how much of your annual allowance remains.

If you are not sure what your mortgage permits, find the commitment letter and look for a section headed prepayment privileges. Send it to us if it is unclear, and we will tell you what you are entitled to.