Paying off your mortgage faster can pay huge dividends
Mortgage holders can save thousands and be mortgage-free years earlier
Paying down your mortgage faster. It's one of those boilerplate suggestions that financial advisers love to make to their clients. After all, throwing extra money at the biggest debt most Canadians have can result in big interest savings and being mortgage-free years sooner.
So why isn't everyone doing that?
According to a spring analysis by the chief economist at the Canadian Association of Accredited Mortgage Professionals, only 35 per cent of Canadians with mortgages took some kind of action in the past year to speed up the date of their "burn the mortgage" party. That suggests that almost two-thirds of those mortgage holders paid off their mortgages as the contract dictated, at least over the previous year.
A recent survey (carried out on May 21-22) commissioned by CIBC and carried out by Angus Reid found that only 55 per cent of 1,509 online respondents with mortgages had taken some kind of action to repay their mortgages faster since they'd originally bought their homes.
Since mortgage payments are made with after-tax dollars, putting extra money down on a debt with an interest rate of 3.49% is equivalent to getting a guaranteed, risk-free return of over five per cent for most taxpayers. If your mortgage rate is higher, your return would be higher too.
So why the seeming reluctance by many to do this?
Mortgage experts say personal circumstances are often at the top of the "why not" list.
"Young families or first-time buyers are in an expensive period of life and are unlikely to have much free cash to put towards their mortgage," points out Jason Scott, a mortgage associate with TMG The Mortgage Group in Edmonton and author of Approved! Mortgage Advice for all Stages of Life.
Others, he says, may be sensibly tackling other debts first. "If they have more expensive debt, like credit cards, it's better if they pay off the more expensive debt first," Scott told CBC News.
Industry players say it's also true that, in these days of lower mortgage rates, it may be a tougher sell to persuade consumers that it's worth tackling mortgage debt at all.
You also won't have to dig too deeply to find people who tell you that, regardless of today's lower rates, they just don't have the extra money to tackle their mortgage debt.
I owe, I owe...
After all, we're repeatedly told we're in hock up to our eyeballs. We've all seen the comments tut-tutting Canadians about their debt levels.
The governor of the Bank of Canada scolds us. Bankers, regulators and politicians wag their fingers in warning. We'll be sorry, they say, when interest rates go up if we still have these big debts.
The debt stats do seem daunting: The level of household debt relative to disposable income was a near record 163.2 per cent in the first quarter of this year, Statistics Canada says. That means Canadians owe just over $1.63 for every $1 in disposable income they earn in a year.
That can make it tough to whittle away at the $1.1 trillion (that's trillion, with a "t"), that we owe on our mortgages, especially when we have another $507 billion in higher-interest consumer credit debt on top of those mortgages.
Viewed against this backdrop, it may then be somewhat of a minor miracle that, in the midst of such a supposedly bleak financial landscape and the competing demands for our extra money (like saving for retirement and the kids' education), many Canadians are actually taking steps to pay down their mortgage debt faster than their mortgage contracts dictate.
And make no mistake. Paying off your mortgage faster can pay big dividends.
How much money can you save? It depends on which strategy you use.
Here are four that can put a surprising amount of extra money in your pocket over time:
Strategy 1: Increase the amount of your payments
Throwing just $100 a month extra at your mortgage can result in formidable savings. Let's assume a $250,000 mortgage at 3.49%, amortized over 25 years. Monthly payments would be $1,247.
Boost that payment by $100 to $1,347, and something magical happens. You'd save $15,400 in interest charges over the life of the mortgage (assuming a constant interest rate of 3.49%) and you'd pay it off three years sooner.
Strategy 2: When you renew, keep your monthly payments the same
Let's assume you took out a $250,000, five-year fixed mortgage in 2009 at an interest rate of 5%. Your monthly payments have been $1,454. Now, it's time to renew and your bank is offering you 2.99% for the next five years. As a result, your monthly payments would drop to $1,224.
Great! But what if you keep on with the $1,454 payments you're used to? That extra $230 a month over the remaining life of the mortgage will allow you to pay off your mortgage four years sooner and you'll save $15,700 in interest. Not bad for just maintaining the status quo.
Strategy 3: Choose an accelerated payment option
This is almost painless. Let's use the example of the $250,000 mortgage described in strategy one. Your monthly mortgage payment is $1,247. Divide that by two, and you get $623.50. Now arrange to pay this amount every two weeks. Because a pay-every-two-weeks strategy results in 26 payments of a half-month's mortgage payment, you end up paying the equivalent of 13 monthly payments a year – or an extra monthly payment every year.
This is what's known as an accelerated bi-weekly payment. Don't just opt for bi-weekly – you want the method that forces you to pay the equivalent of an extra monthly payment each year.
This strategy alone would save the borrower more than $16,300 in interest over the 25-year life of the mortgage. And that 25-year mortgage would also be paid off in a little more than 22 years.
Strategy 4: Make a lump-sum payment
Most closed mortgages (but not all) allow borrowers to pay off up to 10%, 15% or 20% of the original principal in each calendar year without penalty.
Thanks for nothing, you say. "I don't have $50,000 to throw at my mortgage." The good news is that you don't need to pay down the entire 20 per cent. Throwing even a few hundred dollars at it here and there can make a big difference.
One popular suggestion is to put your tax refund to work this way. Assuming we have the $250,000 mortgage described in strategy one, and applying a $1,600 annual payment that the Canada Revenue Agency says is the size of the average refund, that manoeuvre alone would see that mortgage paid off three and a half years early and the mortgage holder would save $20,000 in interest.
When using an online mortgage calculator, make sure it's a Canadian one. American mortgages are calculated differently.
Combining two or more of these strategies would result in even bigger savings.
Fortunately, it's easy to virtually play around with various payment scenarios. Most financial institutions, banks, and mortgage brokers have online mortgage calculators that can spit out the savings for you.
Here's a particularly useful one.
And another one.
And here's a good one from the federal government's Financial Consumer Agency of Canada: