If your goal is to pay down your mortgage faster, or if you are thinking of breaking your mortgage early by selling your property, you'll want to know the details in your prepayment clause. This might be a paragraph of text in your mortgage agreement, or it could be abbreviated as a pair of numbers (10/20 or 20/20). Either way, it tells you how much extra you can pay on your mortgage without incurring penalties. Additional payments go directly to your principal mortgage amount, so they decrease the amount of time you will have your mortgage (the amortization) as well as saving you interest payments over time.
There are 2 ways you can pre-pay your mortgage:
- increasing each payment you make; and
- making a lump sum payment.
Increasing Your Regular Payment
The details vary between lenders, but generally you can increase the amount of your regular payment by a set percentage each year; depending on the lender, this may be a percent of the original payment or the current payment.
For example, if your regular payment is $1,000 and your prepayment clause states that you can increase your payments by 10% of the original amount each year, you could choose to make payments of $1,100 in any year of your mortgage, $1,200 in the following (or any later) year, and so on.
Most Canadians take mortgage terms for 5 years, and a lot can change during that time. You might get a pay increase and want to put that additional income towards your home. You might pay off other debts, such as a car payment or student loan, and be able to redirect that cash flow to your mortgage.
Making a Lump Sum Payment
Again, you'll need to check with your specific lender, but most allow you to pay a percent of the original mortgage loan amount each year. This may look like a single large payment on your anniversary date, or a combination of additional payments throughout the year that are equal to or less than the allowed lump sum amount.
For example, if your original mortgage amount was $500,000 and your prepayment privilege is 20% annually, you could make an additional $100,000 payment against the principal each year. While that may seem like a lot, you can make any payment between $100 - $100,000 that will go towards your principal balance.
You might be in the position to make a lump sum payment if you get an unexpected bonus at work, receive an inheritance, or choose to put your tax refund towards your mortgage principal. If you're making a significant lump sum payment to your mortgage, it's always a good idea to check with your financial advisor to ensure your money is working in the best way possible for you. If you don't have a financial advisor, our trusted partners at Shoreline Financial Services can assist with your financial plan.
What About Mortgage Penalties?
If you stay within the prepayment privileges outlined by your mortgage lender, you can make those increased payments without incurring any penalty. If you are paying out the full mortgage amount, including if you are selling the property, you will also need to pay the lender a penalty as outlined in your mortgage agreement. Essentially, the lender is trying to recoup the interest they would have made during the remaining term of your mortgage. Think of it as a return for their investors – you wouldn't appreciate it if one of your investments didn't yield any results despite being locked in for a specific rate of return.
Mortgage penalties can be complicated, especially when you're considering Interest Rate Differential (IRD), so we've put together a video to walk you through it.
The bottom line is that there are many ways you can pay down your mortgage faster, saving money in the long run. When you work with the Auxilium Team, we review each clause of your mortgage agreement with you so that you have all the information you need to make the best decision for your situation. If that sounds like the type of service you want from your mortgage broker, start a conversation with us today.
Auxilium Mortgage Corporation is based in Victoria, BC and works with clients locally and across Canada. The Auxilium team has over 100 years of combined financial experience and access to dozens of lenders to help you meet your goals.
Updated February 2022; originally posted May 2021