March 3, 2011

It Pays To Know Your Options

There are a number of ways for homeowners to pay off their mortgage faster. Kevin Lutz looks at the available choices.

Kevin Lutz, regional manager, mortgage specialists, Royal Bank of Canada

Most mortgages have great options to help you pay down your mortgage faster – and you should be diligent in asking about these options when getting a new mortgage, and diligent about utilizing them once you have a mortgage. If you use all of your flexible payment options to their fullest, you could prepay as much as 20 per cent or more of your original mortgage balance each year and save a substantial amount of interest. Each of the following options can help you build your home equity faster and get you mortgage free.

Accelerated Bi-weekly Payments
You can save interest by increasing your mortgage payment frequency. When you select an accelerated weekly or bi-weekly payment option, you are essentially making the equivalent of one additional monthly payment each year, which will help pay off your mortgage faster. Scenarios 1, 2 and 3 compare monthly, accelerated bi-weekly and accelerated weekly payments. Tip – make sure you ask about, and understand the difference between regular and accelerated bi-weekly payments.

Interest Saving Example Scenario 1: Monthly payments Scenario 2: Accelerated bi-weekly Scenario 3: Accelerated weekly
Payment $ 1,664.32 $ 832.16 $ 416.08
Term Interest Cost $ 66,256.53 $ 65,036.82 $ 64,991.45
Amortization Interest Cost $ 249,152.06 $ 208,476.05 $ 208,197.95
Proposed Amortization 30.0 Years 25.8 Years 25.8 Years
In this chart we assume the following: (i) a constant interest rate throughout the amortization period, (ii) interest is compounded semi-annually for fixed interest rates and each payment period for variable interest rates; and (iii) the payment schedule you selected is maintained with no additional payments or skipped payments, unless selected by you. Royal Bank of Canada does not make any express or implied warranties or representations with respect to any information or results in connection with these calculations. Royal Bank of Canada will not be liable for any losses or damages arising from any errors or omissions in any information or results, or any action or decision made by you in reliance on any information or results.

Double-up Your Payments
When you double-up a payment, your extra payment goes directly toward reducing the principal balance of your mortgage. A common option is that you can pay up to the equivalent of your regular monthly mortgage payment, whether it’s weekly, biweekly or monthly.

Make Extra Principal Prepayments
Applying prepayments directly to your mortgage principal allows you to prepay a certain amount (usually 10 per cent) of the original amount of your mortgage once in every 12-month period. And when your mortgage is up for renewal, you can make a principal prepayment for any amount you wish. A principal prepayment of even $1,000 a year can make a sizable difference in the time it takes to pay off your mortgage.

Increase Your Payment Amount
Some mortgages allow you to increase the amount of the principal and interest portion of your mortgage payment by as much as 10 per cent once a year. The increased amount goes directly toward your principal. Save more – make a larger down payment. A simple fact is this: Paying off your mortgage faster starts with you saving for a larger down payment. As simple as this is, it can be a difficult choice because buying a home sooner is often a market timing issue, or you have found the right one to buy and it is available now.

Increase Your RRSP Contributions
Under the federal government’s Home Buyer’s Plan, first-time homebuyers are eligible to use up to $25,000 in RRSP savings per person ($50,000 for couples) for a down payment on a home. The withdrawal is not taxable as long as you repay it within a 15-year period. To qualify, the RRSP funds you plan to use must have been in your RRSP for at least 90 days.

Choose a Shorter Amortization Period
A shorter amortization period means higher regular payments, but it also means that you’ll pay significantly less interest over the life of your mortgage. You can choose a shorter period when you set up your mortgage or when you renew it. Paying off your mortgage quickly takes some discipline and is not easy. But remember that every little bit helps. When you make an extra payment against your mortgage, the interest is now calculated on a lower principal balance. Most of these transactions can be done via on-line banking now, making it more convenient for you. Finally, go to your financial institution’s website and use their mortgage calculators to determine the effect of your extra payments.

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