What is mortgage prepayment?

Mortgage prepayment clauses in your contract allow you to pay down the mortgage faster than the monthly payment schedule or amortization. Some lenders will allow a maximum of 20% in additional payments each year without a penalty. You might choose to make a lump sum payment or increase your monthly payments over time. About 30% of borrowers choose to make additional payments to the principal in order to save on interest.

The mortgage qualification rules state that a lender must use a certain formula to calculate affordability. This is so the borrower has a margin of safety in case their circumstances change. Over time, you may have an increase in income or receive a windfall from the sale of assets or an inheritance. You may want to consider making additional payments on your mortgage.

Making a prepayment allocates capital to a debt which saves on interest. However, you may want to consider the “opportunity cost” of paying down a mortgage at 3% compared to investing your capital at a higher rate. Some Canadians choose to make an RRSP contribution and a use the tax refund to pay down their mortgage.

Another way to make mortgage prepayments is to use an “accellerated payment schedule”. Payments are made weekly or bi-weekly, perhaps timed with your paycheque, so that less interest accumulates in each interest period. In Canada mortgage interest is calculated bi-annually so the more you can pay down every six months, the lower the new interest charge will be. Bi-weekly payments can reduce the amortization period by several years.

While you are shopping around for a mortgage, ask questions about prepayment privileges and charges. Follow up with potential lenders by asking about anything that is not clear. Looking at these details closely while shopping for a mortgage could save you thousands of dollars if you want to make prepayments later.

Before signing your mortgage agreement, it is your responsibility to read and understand the terms and conditions, including those related to prepayment privileges and charges.

Questions about mortgage prepayment? Contact one of our sales representatives for more information.