Early Mortgage Repayment, All About It
If the real estate credit is generally essential for the purchase of a house, the duration of this loan can seem much too long. In Quebec, mortgages are amortized over a period of up to 25 years with rates that are more or less high.
Most borrowers want to pay off their debt more quickly by prepaying their mortgage. Équipe Caron draws on its expertise as a multi-loan mortgage brokerage firm to explain this life-saving operation in detail!
What is a prepayment and its conditions?
Prepayment of a mortgage is when a borrower pays off the debt before the maturity date of the mortgage. While it is possible to increase the amount of payments or make lump sum payments, you must beware of prepayment penalties.
Increase the amount of payments
Many banks and lenders allow you to increase your monthly payments by up to 20%. This is ideal if you are receiving a salary increase. However, we recommend that you round up the repayment amount to the nearest $10.
What is the advantage of increasing the amount of your mortgage payments? This technique has a great impact on your schedule and allows you to pay off your loan early without impacting your living expenses! However, the increase in your payments may be capped at a certain annual amount.
At Équipe Caron, we offer you a customized service to avoid prepayment penalties. Find out and obtain the mortgage rate for which you are eligible by contacting one of our experts!
The lump sum payment
This is a good way to pay off your mortgage early with an occasional cash inflow. You can use:
- a tax refund,
- a year-end bonus,
- of an inheritance…
However, make sure that your mortgage agreement does not include a flat payment fee. The bank may also grant you a prepayment privilege. In this case, you are allowed to pay back an additional amount to your usual payments, either by a single payment or by regular deposit of a certain percentage.
Why make an early mortgage payment?
The first benefit of making an early mortgage payment is related to saving on interest costs. Interest is the true cost of the loan and can represent a significant amount of money over the long term and can be a burden to the borrower.
Early repayment of the mortgage also allows you to reduce the term of the loan. This results in a significant gain in loan insurance, but also in peace of mind. With this sense of accomplishment, you can focus on other projects.
When to make a prepayment?
According to the legal provisions in force, a borrower may, at any time, decide to proceed with the early repayment of his mortgage loan. Moreover, the bank is not allowed to oppose this operation, except in the case of a partial repayment of 10% or less of the initial loan.
Prepayment is the payment of the outstanding principal of your mortgage. It can therefore give rise to penalties or reduce your living expenses if it is not properly planned. As such, we suggest that you wait until your mortgage is renewed to review your contract and its repayment terms.
What to think about before making a refund?
Paying off your mortgage as quickly as possible is not always the best strategy. Before considering this option, you should analyze your financial situation, your plans and current interest rates.
You should never prepay your mortgage at the expense of your personal finances. So make sure:
- have sufficient savings or an emergency fund,
- to hold other forms of savings,
- to be able to prepare for your retirement and pay for your children’s education despite the early repayment.
Before making a prepayment, we recommend that you have no debt with a higher interest rate than this mortgage.
Alternatives to accelerate the payment of the mortgage
There are many ways to prepay a mortgage. Here, Team Caron presents the three most reliable solutions!
Reduce the amortization period
Shortening the amortization period is the best solution to accelerate the repayment of your first mortgage or if you need to take out a new contract. Opt for a 20- or 15-year term, depending on the options offered by your lender. However, you must take into account your financial capacity, because a shorter amortization period means higher monthly payments.
Increase the frequency of payments
Do you have a higher regular income? Do you have new sources of income? Don’t hesitate to synchronize your mortgage payments with your new income to accelerate your mortgage payments. You can opt for accelerated weekly or bi-weekly payments when you renew your contract.
Renegotiate/reduce the rate
The time to renew your mortgage is also the perfect time to get a better interest rate! With a lower interest rate and the same payment amount, you are sure to pay off your loan faster.
To take advantage of this, simply compare offers from different organizations and transfer your mortgage to a new financial institution. However, there may be a discharge or registration fee.
Mortgage prepayment fees
If the prepayment of your mortgage exceeds the limits set by the bank, you are subject to penalties. The calculation of these fees depends on the type of loan taken out.
Closed variable rate loan
The prepayment fee is equivalent to 3 months of interest calculated on the prepaid amount. The rate used corresponds to the prime rate of the lending institution. You can estimate the prepayment fees by using our online calculator.
To better understand this calculation, let’s take the example of Paul wanting to prepay the entire principal ($50,000). With a prime rate of 4.0%, the annual interest is : (50 000 $ x 4)/100 = 2 000 $.
The interest for one month is : 2 000 $/12 = 167 $.
The prepayment fee is therefore : 167 $ x 3 = 501 $.
Fixed rate closed loan
With a fixed rate closed mortgage, the repayment fee is determined by two calculations. The first is calculated in the same way as with the variable rate over 3 months of interest, but with your annual mortgage interest rate. The second is related to the interest rate differential (IRD) on the amount paid in advance. The bank retains the higher amount.
For example, Mandy takes out a 5-year mortgage with a 0.50% discount on her interest rate. The annual percentage rate is 6.50% and the outstanding principal is $100,000. In addition, she has 2 years left on her mortgage when she inherits a large sum of money. She then wishes to pay off her entire debt early.
The amount corresponding to the 3 months of interest is first obtained by determining the annual interest on his debt. Here we must consider the annual rate plus the discount, i.e. 6.50% + 0.50% = 7% or 0.07.
The annual interest is : 100 000 $ x 0,07 = 7 000 $.
The monthly interest is: 7 000 $/12 = 583,33 $.
The 3 months of interest is equal to : 583,33 $ x 3 = 1 749,99 $.
For the interest rate difference, calculating the fee based on the outstanding balance ($100,000), the monthly payment ($693.47), the increased interest rate (7%) and the 2-year term, the fee is $13,603.92. If the comparison loan has a rate of 5%, the comparison loan fee is $9,567.59. The difference in interest rate is therefore: 13 603,92 $ – 9 567,59 $ = 4 036,33 $.
Ultimately, Mandy will have to pay $4,036.33, the higher of the two calculations.
Do you want to make an early repayment to accelerate your mortgage payment? Get the best rate by contacting our team of Canadian experts!