With mortgage interest rates hovering between two and three per cent, borrowers don't seem to be in a rush to pay off their mortgage. Contrary to believing "borrowing cheap money" is the best way to go, now could be a great time for Canadians to get serious about wiping out, or significantly reducing, their mortgage debt.
Recent data from CIBC shows that fewer Canadians are paying off their mortgages early. Last year, 68 per cent of those who had a mortgage said they were working to repay the loan ahead of schedule. This year, that number had dropped to 55 per cent.
Across the country, poll respondents anticipated being mortgage debt-free by age 58. But in British Columbia that age stretches to 66. Paying off a mortgage is especially important for anyone with a higher interest rate, or those who really value mortgage freedom (such as older, retired people).
If you'd like to shave five years (or more) off your mortgage, read on for three strategies that can help. But first, a few caveats to keep in mind:
• Some lenders only allow prepayment on the anniversary date of your mortgage, which makes it harder to accelerate your mortgage payoff in a meaningful way.
• Lenders that do allow prepayment may still impose prepayment penalties if you exceed the percentage of prepayment allowed (often 10 to 20 per cent per year). Prepayment penalties typically equal up to three month's interest on your current mortgage or the interest rate differential, whichever is higher. Prepayment penalties usually happen when clients want to fully pay off their mortgage. Rather than paying the penalty, it may make more sense to prepay up to the maximum allowed percentage and then make a larger lump sum payment at renewal.
• If you have higher-interest debt, such as credit cards, you should focus on paying down those debts before you get aggressive about prepaying your mortgage. Mortgages are secured by the property, so they carry a lower interest rate than unsecured loans, such as credit cards. Paying your mortgage on schedule and wiping out higher-interest debt first means you'll pay less in interest. Of course, consolidating debt and matching current monthly payments into new mortgage payments would be a great way to get out of debt and pay off your mortgage sooner.
• Do not prepay your mortgage at the expense of your retirement savings. Homeowners like the idea of being mortgage-free in retirement, and while this is a great goal, sacrificing retirement savings in order to wipe out a mortgage could backfire because it means missing out on tax incentives and compound interest. I tell clients that if you can make your money work better for you in investments, don't be in such a rush to pay off a mortgage with a low interest rate.
Ask your mortgage broker if you're unsure about whether your mortgage lenders allows prepayments. Then consider these steps that could allow you to knock several years off your mortgage and save thousands of dollars in the process. For the sake of illustration, let's say you have a $350,000 mortgage amortized over 25 years at a rate of 3.5 per cent (that rate is a bit high by today's standards, so let's say you bought the property a few years ago).
• Increase the frequency of your mortgage payments. Instead of making monthly payments, opt for biweekly ones. Over the course of a year you'll send in 26 payments instead of 12. If you receive biweekly cheques from work, this approach could also help you budget by making your housing payments mirror the frequency of your paycheques. You could even make weekly payments, if you prefer. Say your existing monthly payment was $1,797. Your new payments would be $874 (biweekly) or $437 (weekly). With either frequency, you'd save over $23,000 in interest and remove three years from your amortization.
• Increase the size of your mortgage payments. Bumping up each mortgage payment by $50 (the equivalent of one dinner or 10 takeout coffees) will remove five or six years from your amortization. If you're already doing accelerated biweekly payments, adding an extra $50 would make your payment $924. That extra bump would save $36,718 over the course of the loan and remove five years of payments. With accelerated weekly payments of $478, you'd save a whopping $47,853 and six years.
• Make a lump-sum payment. If you get a sizeable bonus or salary increase, you might put that extra money towards your mortgage. Or if your lender only allows lump sum prepayments at a mortgage anniversary, save up that extra money in a TFSA and apply it when the time comes. If you accelerated the frequency of your payments, added an extra $50, and made a lump-sum payment of $1,000 each year, it would save you over $55,00 and reduce your amortization by seven years! The majority of lenders allow lump sum payments as low as $100.
Once your mortgage is paid off, you'll have more financial flexibility and greater peace of mind that if something happens -- say, you lost your job or needed to take time off to care for a sick relative -- you'll always have a roof over your head.