What is Accelerated Mortgage Payments
Accelerated payments have become a popular method among Canadians to pay off their mortgages before the end of the amortization period. On average, it takes Canadian households around 20-25 years to own their homes and pay off their mortgages. Nevertheless, couples can use various means such as a salary increment, job promotion, inheritance, or being financially responsible to reduce this duration by utilizing their newfound capital.
Definition of Accelerated Payments
In Canada, most homeowners prefer to pay their mortgage monthly, as it is the standard practice offered by financial institutions. However, accelerated payments provide an alternative option for homeowners who seek more flexibility in their payment schedule. Accelerated payments involve making an additional monthly mortgage payment each year, which means that instead of 12 payments per year, homeowners make 26 payments every two weeks. Alternatively, if homeowners opt for accelerated weekly payments, they will make a total of 52 payments per year.
How Does an Accelerated Bi-weekly Payment Differ From a Semi-monthly Payment?
Accelerated payment schedules can be a great financial tool for those looking to save money in the long run. By making biweekly or weekly payments, you can significantly reduce both the length of your amortization period and the amount of interest you pay on your mortgage. This can result in savings of several thousands of dollars over time, which can be put towards other financial goals, such as saving for your children’s education or investing in a retirement portfolio. Additionally, by avoiding spending this extra money on your mortgage, you can use it to purchase a second property or make home renovations. An accelerated payment schedule can help you achieve your financial goals faster and more efficiently.
What are the advantages of expediting the payment of your mortgage?
Many individuals opt to expedite their mortgage payments to decrease the overall amount owed.
Additional payments are typically allocated towards the principal, reducing the total mortgage amount on which the interest rate is calculated. To illustrate, if your interest rate is 1% of your principal and your principal is $100,000, you would owe $1,000 in interest. However, if your principal is $50,000, you would only owe $500 in interest.
Sure thing! Are there any charges involved?
The fees depend on whether you have an open or closed mortgage. Open mortgages allow you to make significant lump sum payments and fully repay your mortgage ahead of schedule without any additional charges. However, open mortgages are uncommon in Canada and typically come with higher interest rates than closed mortgages.
On the contrary, if you decide to pay off a closed mortgage before its maturity date, you might incur certain prepayment penalties. Closed mortgage rates are generally lower than open mortgages; this can be seen as compensation for being unable to pay off your loan early.
How much do prepayment penalties cost?
Although they can be significant, they don’t have to be a deal-breaker if you plan ahead. Financial institutions usually charge either three months of interest on your mortgage or the interest rate differential (IRD), whichever is higher.
Regarding the former penalty, lenders will typically use one of two interest rates: either the one from your original mortgage contract or the current interest rate. Suppose the lender opts to charge the IRD. In that case, they will multiply your mortgage balance by the difference between the interest rate you agreed to when you obtained your loan and its current posted rate. Then, they will multiply that by the number of months remaining on your mortgage and divide it all by twelve.
Don’t worry if this sounds a bit confusing. Let’s consider an example to help clarify things. Suppose you have a $100,000 mortgage with a 5% interest rate and 36 months left on your mortgage contract. Your lender’s current posted interest rate is 2.5%, resulting in a difference of 2.5%.
In this case, the prepayment penalty would be calculated as follows: (the remaining balance x interest rate difference x remaining months) / 12. By plugging in the numbers, we get ($100,000 x 2.5% x 36) / 12 = $7,500. Therefore, if you were to prepay your mortgage in this hypothetical scenario, you would be charged a $7,500 penalty.
Do I have any other alternatives available?
We understand that accelerated mortgage payments may not be suitable for everyone. You might not want to go through the hassle of sorting everything out or dealing with the associated fees. Your mortgage may be too large to consider this option. If you only need a small amount of extra funds, you could explore the possibility of mortgage refinancing. Although the process can be complex, it can reduce your interest rate and release some capital from your home.
While accelerated mortgage payments can be an effective strategy for reducing your debt burden, it’s important to note that they often come with high fees due to the prevalence of closed mortgages in Canada. Before deciding, it’s crucial to fully understand the financial impact of accelerated mortgage payments. If you require further assistance, it may be beneficial to consult a financial professional who can cater to your specific needs.
Sure, sure - I'm convinced! Now, what steps do I need to take to secure an accelerated mortgage from my financial advisor or lending institution?
Qualifying for an accelerated mortgage follows a similar process to that of a regular monthly payment plan. However, some lenders may suggest or mandate that you meet a specific income threshold before granting approval. This is because accelerated payments require a significant amount of discipline and financial stability beyond what is typically needed for a monthly mortgage.
Struggling to keep up with your accelerated mortgage payments?
Don’t worry; there are options available to you. Firstly, it’s important to remain calm and avoid panicking. Your bank won’t repossess your home without warning. Instead, reach out to your financial institution and explain your situation. In the meantime, continue making your payments until your bank approves any changes to your payment schedule. The good news is that most banks and credit unions in Canada allow you to adjust your mortgage payment frequency at any time. If you need further assistance or information, please get in touch with us at Superb Mortgages. Our team is always available to provide support and guidance.