Mortgage Prepayment Benefits and Penalties: A Guide
Are you considering paying off your mortgage earlier than what the term requires? If you’re able to do so, it’s a good idea to read up on the conditions of your mortgage agreement before making the leap. Today, we’ll go over the benefits of prepaying a mortgage as well as the risks, the latter of which is in the form of penalties.
Let’s explore this topic in more detail to help you make informed choices.
Benefits of Prepaying Your Mortgage
The main benefit of prepaying your mortgage is that you can save a lot of money on interest. You may be able to pay it off years ahead of schedule and gain full possession of the home. If you pay down your mortgage faster, you acquire more equity in your property as well, which offers you more flexibility later on if you’d like to consolidate your debt, make home improvements, or finance a major purchase.
Ways to Pay off Your Mortgage Early
There are several ways you can prepay your mortgage, which may or may not be ideal for the terms and conditions of your agreement. These include the following:
A Lump Sum Payment
A lump-sum payment is a great way to pay off the remainder of your loan, but making a large payment may result in exceeding your mortgage prepayment privileges. These limit how much you can overpay each month, and a lump sum payment is sure to trigger a prepayment penalty if you exceed yours.
Increasing Your Payment Amount
Even if you pay a little more than you’re required to each month, it can make a difference over the life of your loan. Each time you pay more than your regularly scheduled payment, the extra money goes to pay down your principal. Interest is applied each month based on your outstanding balance, so people save a lot of money by paying the principal down faster than they’re required to.
Even paying an additional $60 per month can reduce the total duration of your loan by five or six months. Since you’re paying down principal, you’re also building equity every time you pay a little more than you’re required.
You likely have the option to choose an accelerated payment schedule that allows you to pay your mortgage down faster. Rather than making one payment a month, for example, you could choose accelerated bi-weekly payments or accelerated weekly payments.
You can pay off your principal rapidly when you choose an accelerated weekly payment plan. The average accelerated payment plan is essentially like making one extra mortgage payment every year.
Mortgage Prepayment Penalties
Mortgage lenders don’t hold a favourable view towards early mortgage payments. A lender might charge you a penalty if you do any of the following:
- You pay more during a month than the amount of prepayment you’re allowed under the terms of the loan
- You refinance your home and transfer payments to another lender, who pays the original lender your outstanding balance
- You breach the terms of the mortgage, such as by defaulting on the loan and going into foreclosure
- You sell your home and then repay your mortgage with the money from the sale
How Penalties are Assessed
There are a variety of factors that a lender uses to determine your penalty amount. It can vary by how much you pay, the remaining amount of time on your loan, what the current interest rates are, and how the lender prefers to assess these fees. Normally, if you pay off the entire loan early, the prepayment fee will either be three months of your current interest rate or an interest rate differential (IRD).
The IRD penalties can cost thousands of dollars, so it may not be in your best interest to prepay your mortgage in some instances. If you’re not going to save more money by prepaying the loan than what the penalties are, you’d be better off continuing to make your regular mortgage payments.
How to Avoid Prepayment Penalties
Here are some ways that you can reduce or even eliminate your mortgage loan prepayment penalty:
Pay Attention to the Terms of Your Loan
Before you take out your mortgage, you should shop around with multiple lenders to find the best option for you. Many people are looking beyond the monthly payment and closing costs. Some lenders are a little more old-fashioned than others when it comes to their penalties, so decide early on whether the option to pay your mortgage off early is important to you, and only accept loans with favourable pre-payment terms. For example, if you have a fixed-rate mortgage, many mortgage companies will offer smaller penalties compared to bank penalties.
Do Your Homework
If you’re going to refinance or move into a new home, use a mortgage calculator to determine what your new payment and costs will be. Then consider how the prepayment fees will impact your decision. Sometimes, if you’re refinancing at a much lower rate, your savings cover the penalties.
Prepay in Smaller Installments
As long as you prepay within your privilege amount, you don’t need to worry about these fees at all. Most lenders will allow you to pay 10% to 20% of the original loan amount each year on top of your normal payments. Just pay a little extra each month so that you can exit the mortgage months or years in advance.
Work With a Broker
Chris Allard has many years of experience working with a team of talented and knowledgeable mortgage professionals. If you’re looking for a new home, he and his team can help you figure out the best way to handle your existing loan. Together, it’s a great way to explore your available mortgage options so that you get the best deal possible on the home you want the most. Chris has connections with over 50 different lenders, so he can connect you with those that don’t charge a high mortgage prepayment penalty.
Interested in exploring your prepayment options? We’re happy to assist. Contact us to learn more and get started today.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Smart Debt Mortgages, independently owned and operated. Smart Debt broker #12236.