Paying Off Mortgage Early

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Paying off your mortgage allows you to live debt-free, which can be a relief, especially as you approach retirement. You will no longer need to make monthly mortgage payments and may have extra money to travel or pursue new hobbies. Read on to learn more about the best ways to pay off a mortgage early without having to pay significant mortgage prepayment penalties.

Your approach to paying off the mortgage depends on whether you have an open or a closed mortgage. Open mortgages have a higher interest rate but allow you to prepay an unlimited amount of your mortgage. However, most mortgages in Canada are closed mortgages, which generally let you pay no more than 20% of the principal every year. If you prepay more than 20% in a year with a closed mortgage, you will be charged prepayment penalties, which can cost you thousands of dollars. You can refer to your mortgage contract or talk to your lender to learn about your prepayment privileges. Listed below are ways to pay off your mortgage early, especially if you have a closed mortgage.

1. Make Lump Sum Payments
   • Annual Lump Sum Payments: Almost all mortgage lenders in Canada allow you to make an additional lump-sum payment each year without any penalties. This approach is great if you receive an annual bonus or inherit some money. The payment typically can't exceed 20% of your mortgage principal. For example, if you have a remaining principal balance of $100,000 on your mortgage, you can prepay up to $20,000 this year. Annual lump-sum payments will let you pay off your mortgage faster if you choose to keep similar or increased monthly mortgage payments in your next term.
   • Large Lump Sum Payments at Term End: You can make a large lump-sum payment or even pay off the entire mortgage when your term matures without any penalties. This can be a great way to use any extra money you have saved. This lump-sum payment will save you significant interest costs and help you become debt-free sooner.
2. Switch to Accelerated Payment Options

   More frequent payments, such as weekly or bi-weekly, instead of monthly payments, can help pay off your mortgage faster. By switching to accelerated bi-weekly payments, you will end up paying more in a year compared to monthly payments. A biweekly payment plan will have 26 payments over the year as opposed to the 12 monthly payments in the year, but you will pay half of the monthly payment every two weeks. For example, if your monthly mortgage payment is $1,000, your accelerated bi-weekly payments will be $500. Thus, you will end up paying $12,000 with a monthly payment plan in a year, but you can pay off $13,000 with a biweekly payment plan.

   You basically make one extra monthly payment each year without noticing a major difference in your wallet. The best part is that there are no prepayment penalties for doing this. If you want to switch to accelerated bi-weekly payments, you must contact your mortgage lender and request the change.

3. Increase Monthly Payment

   Most lenders will allow you to increase your regular monthly payments by up to 20% without any penalties. For example, if your monthly mortgage payment is $1,000, you can increase it to $1,200 per month. Most mortgage lenders also allow you to make a double mortgage payment once per year.

   This method is excellent if you receive a significant pay raise. The increased payments will help you pay off your mortgage faster and save on interest costs. Be sure you're comfortable making the larger monthly payment before increasing it.

4. Renew to a Shorter Amortization

   If you don't have the money to make a lump-sum payment, you can also pay off your mortgage faster by renewing to a shorter amortization. For example, if you have a $100,000 mortgage with a five-year term amortized over 25 years, at the end of your term, instead of renewing into another term with 20-year amortization, you can renew to a term with 15-year amortization. This will increase your monthly payments, but you'll pay your mortgage faster. Just be sure to shop around for the best mortgage rate before renewing.

5. Renew to a Lower Mortgage Interest Rate

   Each mortgage payment contributes to your mortgage principal and interest. A lower mortgage interest rate means more of each payment is directed to paying your principal. If you are up for renewal, you can pay off your mortgage faster by renewing your mortgage at a lower interest rate but keeping your monthly mortgage payment the same. If you are in the middle of a term, but your lender is offering a lower interest rate than you have for renewal, you can also explore blend and extend as an option to reduce your current interest rate.

   You can usually renew your mortgage with a new lender at the end of the term, making it a great time to shop around and compare mortgage rates from different lenders. Most lenders often offer a promotional rate if you haven't banked with them before. If you mention shopping around, your existing lender may also attempt to match other mortgage rates.

6. Downsize Your Home

   Downsizing to a less expensive home will enable you to free up home equity, which can then be used to pay off your mortgage. If you have a $100,000 mortgage and sell your home for $300,000, you'll have $200,000 in home equity. Your lender may allow you to port your mortgage to another home without penalties. While this method will free up cash, there may be restrictions to pay off your mortgage.

   If you have a closed mortgage, you'll have to pay it off through annual lump sums and increased payments to avoid penalties. If this sounds like a headache, you may prefer waiting for your term to end before using the cash to pay off your mortgage fully.

While you may be tempted to pay off your mortgage early, it may end up being a costly mistake if you’re not careful. Listed below are some mistakes you should avoid when considering paying off your mortgage early.

1. Not accounting for prepayment penalties: If you have a closed mortgage, your lender will charge you a prepayment if you pay more than the permissible extra payments. This can cost you thousands of dollars.

2. Putting all your cash into paying off the mortgage: Real estate assets are considered among the most illiquid assets, meaning they cannot be converted to cash quickly when required. If you put in all your liquid cash and assets towards paying off your mortgage, you may be left with little to no liquid funds for emergencies.

3. Not considering other investment options: While paying off your mortgage early can significantly reduce the mortgage interest you end up paying, you might earn much better returns by investing the same money in other channels, such as stocks, ETFs and high-yield savings accounts instead. For example, let's assume your mortgage is up for renewal, and you have 5 years remaining on your mortgage with a balance of $100,000. Suppose the ongoing mortgage rate of interest is 4%; then, paying off the mortgage at this point will potentially save you $10,410 in interest. Meanwhile, if you decide to keep the mortgage and put the $100,000 in an index that generates a 6% annualized rate of return for five years, you could earn almost $34,000 in interest. Subtracting the mortgage interest from this amount, you could still make a profit of over $20,000.

   However, you should note that markets are volatile, making investing in them risky. You should also remember that you might have to pay taxes on your investment returns based on the type of investment account you use.

4. Not putting the extra payments towards paying down the principal: While you may be making extra payments now and then, your lender may be using the extra payments to pay down the interest for your next payment rather than applying it directly to the principal. You must talk to your lender and ensure that the extra payments are going towards the principal.

While paying off your mortgage will remove your most significant debt, it's not the best strategy to increase your net worth. If you are sitting on a chunk of cash, investing in a rental property will likely provide you with a higher return on investment.

You will have two properties that appreciate. Additionally, the rent your tenant pays should cover the costs of your new property and provide you with some additional cash flow. Each payment your tenant makes will contribute to your mortgage amount, meaning you'll build home equity ownership in the rental property. However, you will have to deal with the stress of managing two properties. This can include evicting a tenant, property repairs, and managing tax reporting.