Pre-payment Strategies
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First off bookmark this site, it will help you in the future in making decision regarding your mortgage as well as in your purchase and financing arrangements. If you have been playing with the payment calculator or downloaded the mortgage wizard available on this site, you will soon see how much interest you are paying over the course of a mortgage loan. Without taking advantage of some simple strategies available to you, you could easily pay the amount of your mortgage twice over. It is my intention here to provide you with the information and some suggestions for reducing your overall interest cost. I will show you several methods and you don't have to be a spend thrift to accomplish them. Some of you may use all these methods and gain the biggest savings, but even for those on a limited budget there is a method to suit you. |
| In the following example you will see the interest cost on a mortgage loan over 25 years without taking advantage of any prepayment privileges. |
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Mortgage Facts | |
Mortgage Amount |
$100,000.00 | |
Percent Interest |
6% | |
Monthly Payment |
$644.30 | |
Amortization Period |
25 Years | |
Remaining Balance |
$.97 |
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Cumulative Payments | |
Interest |
$93,290.97 | |
Principal |
$99,999.03 | |
Total Payment |
$193,290.00 |
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Mortgage Based On Monthly Compounding |
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| Distribution of Payments |
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| All mortgage companies offer prepayment privileges find out what yours offers. It will vary from institution to institution and what follows are some examples of what is available. |
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Method 1 - |
Most companies will offer payment frequency choices of either monthly, weekly or bi-weekly, while they are not part of the prepayment privileges they can provide you with increased savings cost over the course of your mortgage loan so I have included it here as a strategy. (see below for more details) | |
Method 2 - |
Most will offer lump sum payments of up to 10 - 15% of the original amount of the mortgage to be applied to principal each anniversary year. (see below for more details) | |
Method 3 - |
In addition to the lump sum payments they usually offer the option of increasing your payment by up to 10-15% each anniversary year. (see below for more details) |
| You can take advantage of all these options and significantly reduce your overall interest costs. Or you can take advantage of the method that suits you best and still achieve some savings in interest cost. |
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| Method 1: |
| Most mortgage companies will allow you to choose between monthly, bi-weekly or weekly mortgage payments. By choosing Bi-Weekly or Weekly payments you will reduce the overall amortization period and interest cost of the mortgage. In the following chart I will show you the savings and reduction in amortization of a mortgage loan for $100,000.00 over 25 years. |
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| Payment Frequency |
Amount of Mortgage |
Interest Cost |
Amortization |
Total of All Payments |
Savings by Paying Weekly or Bi-Weekly | |
Monthly |
$100,000.00 |
$93,290.97 |
25 Years |
$193,290.00 |
0 | |
Weekly |
$100,000.00 |
$75,504.96 |
20.9 | $175,577.20 |
$17712.80 | |
Bi-Weekly |
$100,000.00 |
$75,611.18 |
20.91 | $175,571.75 |
$17,718.25 |
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| Method 2: |
| Applying lump sum payments of 10 -15% of the original amount of the mortgage over the life of the loan. In this example I will use a $100,000.00 mortgage at 6% taken out over a 25 year amortization period, with a payment frequency of monthly payments, with an assumption that the interest rate remains constant, and apply a prepayment of only 1% or $1000.00 each year. In my example the customer is utilizing part of his/her income tax refund cheque to make the lump sum payments. |
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| Lump Sum Payment Date |
Lump Sum Payment Amount |
Original Mortgage Amount |
Balance if No Prepayment | |
0 | 0 |
$100,000.00 |
$100,000.00 | |
Year 1 | $1000.00 |
$97,219.96 |
$98,066.78 | |
Year 2 | $1000.00 |
$94,268.46 |
$96,167.52 | |
Year 3 | $1000.00 |
$91,134.91 |
$94,151.12 | |
Year 4 | $1000.00 |
$87,808.09 |
$92,010.35 | |
Year 5 | $1000.00 |
$84,276.08 |
$87,737.55 | |
Year 6 | $1000.00 |
$80,526.22 |
$87,324.56 | |
Year 7 | $1000.00 |
$76,545.08 |
$84,762.74 | |
Year 8 | $1000.00 |
$72,318.40 |
$82,042.92 | |
Year 9 | $1000.00 |
$67,831.02 |
$79,402.63 | |
Year 10 | $1000.00 |
$63,066.87 |
$76,089.67 | |
Year 11 | $1000.00 |
$58,008.87 |
$72,834.91 | |
Year 12 | $1000.00 |
$52,638.91 |
$69,379.41 | |
Year 13 | $1000.00 |
$46,937.75 |
$65,710.78 | |
Year 14 | $1000.00 |
$40,884.94 |
$61,815.87 | |
Year 15 | $1000.00 |
$34,458.82 |
$57,680.76 | |
Year 16 | $1000.00 |
$27,636.34 |
$53,290.55 | |
Year 17 | $1000.00 |
$20,393.07 |
$48,629.59 | |
Year 18 | $1000.00 |
$12,703.05 |
$43,681.16 | |
Year 19 | $1000.00 |
$45,38.73 |
$38,427.51 | |
Year 20 / 8 months |
$1000.00 |
0 | $34,746.27 |
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| You can see by the above example that even in only taking advantage of a small percentage of the prepayment privilege that the savings can be significant. Now combine that with weekly payments to save even more. |
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| Method 3: |
| Increase your monthly payments by 10 - 15% annually, as determined by the prepayment privileges allowed by your mortgage company. Determine what kind of budgeter you are and if it is easier to increase your payments nominally rather than try to save a lump sum amount this is the method for you. But of course for those of you that can, take advantage of all the options available for the greatest savings. |
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| Your
Personal Banking Officer should be willing to discuss all these
options with you. My suggestion to you would be to find out the
prepayment privileges allowed on your mortgage are and consider and
weigh this in with other bonus's, interest rate reductions and
incentives offered when you are shopping for a mortgage. Then when you
are all settled in your new home and past all the moving expenses, go
back and re-visit with the banking officer and discuss and plan your
strategies then. |
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| Some Other Things to Consider: |
| Now you
are all settled in your home, your children are making new friends in
the neighbourhood and at school and you are finished making all those
personal touches that make the house your home. Whether you are
considering re-financing your home to complete some renovations or to
add a new swimming pool or deck here are some thing to consider about
your mortgage. |
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| First I will explain some terminology commonly used in the financial industry which will make the following information easier to understand. |
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Amortization Period: |
This refers to the length of time it takes to pay off your mortgage. In Canada mortgages can be taken out for up to 25 years. | |
Term of the Mortgage: |
The term refers to the period of time the interest rate is fixed for ranging from 6 months to 10 years. The terms offered vary a little from institution to institution. | |
Open Mortgages: |
These terms are fully open, which means that you can do the following: -
Make mortgage prepayments of any amount, at any time;
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Payout the mortgage at any time without penalty;
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Convert or early renew to another term without penalty.
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Terms offered are generally 6 months to a year at which time they would be up for renewal and could be renewed as an open mortgage again at that time.
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| Situation 1
- Even though you may have selected a 5 year term on your mortgage which is not up for renewal for a couple of years yet, you can still do an early renewal on your mortgage to re-finance for renovations or improvements to the home without suffering a penalty. What most financial institutions will do in this case is offer you a blended rate on the mortgage owing to the remainder of the term and blend it with the new term selected with the current rates being offered. Even if you want to do an early renewal to lock into some favourable interest rates for a longer period of time, depending on how far into the term you are it may be an option open to you. |
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| Situation 2
- Your mortgage is coming due in a couple of months, you received your renewal notice in the mail but the rates don't seem competitive with other financial institutions or you have not been happy with the service provided by your current financial institution. The options available to you are shop around again for the best rate and bonus incentives being offered, then your options are to approach your current banker advising them of the rate you are being offered to see if they will match it or switch your mortgage to another financial institution. Switching your mortgage does not involve redoing the expensive whole mortgage process with lawyers and all, it is all handled by your new lender at usually no cost to you. |
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| Situation 3
- Home Equity Loans or Secured Lines of Credit.
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| There are many products being offered all the time using your home as security and offering you preferred rates of interest. You can take advantage of the equity you have built up in your home to make you eligible for the low interest rates whether you are interested in purchasing a new car, leisure trailer, vacation home or just about anything. This may not always be the best option all of the time but certainly one to consider depending on your circumstance. |
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| Situation 4
- Advantages to having all your banking in one place. |
| When you have a mortgage, retirement savings plan, savings and chequing accounts or any combination of major services, you are considered a preferred customer and will be eligible for preferred rates on car loans or lines of credit. |
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| Situation 5
- Re-financing Your Mortgage to consolidate debts |
| While this may not always be the best option to extend the mortgage loan, in special circumstances it may be the only option and it is good to know it is available to you. My suggestion to you would be utilize this option if it is necessary, take advantage of the lower rates on mortgages to pay off high interest credit cards or loans but try and keep the amortization period remaining the same. It will likely improve your monthly cash flow, reduce overall interest costs, and you can still take advantage of prepayment privileges in the future. Take this time and opportunity to make a budget and plan for your future goals and set up pay yourself first savings, retirement savings and utilize that extra cash flow to invest in your future. |
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| Situation 6
- Selling your home - Mortgage Assumptions |
| You need to sell your home whether it is because your retiring to Florida or due to a breakdown in your marriage whatever the reason - you want to avoid interest penalties on your mortgage that would be incurred by paying it out before the maturity of the loan term. Most mortgages are assumable and can be assumed by the new owners. They can be assumed in the present terms or the new owners can negotiate a increased mortgage loan either with a blended rate or at the current rate. Often times if the mortgage is replaced with a new mortgage of a larger amount even at the lower current rates, the bank will forgive the interest penalty. If the interest rate on your current mortgage is lower than the current rates this can be an attraction to prospective buyers to assume yours either at a blended rate for a larger amount or cash to mortgage. So if you find yourself in this position discuss your options with your lender and advise your Real Estate Representative of these details. |
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| I hope you find some of this information useful, keep checking back for updates or more tools to assist you in your financial planning. |
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