Crush your mortgage

Mortgage documents are full of traps that make it extremely difficult to pay off your biggest debt.

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by

From the June 2013 issue of the magazine.

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Luxury Home
It was a sun-drenched autumn afternoon in 2005 when Heidi Croot and her husband Phil Carey found themselves barreling down Highway 401 toward the picturesque lakeshore community of Port Hope, Ont. Armed with a picnic lunch, the couple was in a celebratory mood. Finally, they were following through on a promise made to each other more than a decade ago: to pay off their mortgage early, free themselves from their well-paying but stressful corporate jobs in downtown Toronto and downsize to the countryside. Croot and Carey, then 47 and 59, had been living north of the city in the commuter town of Thornhill. They were tired of suburban sprawl, not to mention their daily two-plus-hour slog to and from work. Small, quiet Port Hope, some 100 km away from the gridlock and congestion of Toronto, would soon be their new home.

Croot and Carey paid off their 25-year mortgage in 2002, 10 years earlier than expected. With the freed-up income, they were finally in a position to focus solely on building up their retirement savings—and that’s exactly what they did, continuing on with their regular jobs for three years prior to moving to Port Hope. These days, Phil is retired from his engineering career, while Heidi has transitioned to part-time work. Their only regret is that they didn’t ?gure out how to do this earlier.

As the couple will attest, paying off your mortgage is the single most important step towards financial independence and a prosperous retirement. Owning a principal residence outright gives you the financial freedom to funnel money that formerly went to your mortgage into your savings or to pursue lifelong dreams like travelling. Don’t forget, too, that mortgage interest adds tens of thousands of dollars to the real cost of a home, so a shorter mortgage slashes the amount you pay in total. Paying off your mortgage as quickly as possible should therefore be an important goal for any homeowner—whether you’re halfway through the process, just starting out, or even just contemplating buying a house.

If all the above advantages sound compelling, bear in mind that sacri?ces will have to be made. “Paying off the mortgage early wasn’t easy,” Croot says. “We had friends who were going out twice a week for dinner and we didn’t do that.” Without question, tightening up your spending is a key tactic for freeing yourself from mortgage debt, but there are also many other strategies that won’t cost you a dime and can save you thousands. Allow us to let you in on the secrets every prospective and current home owner should know.

Polish off your credit score

If you’ve always paid off your debt in a timely manner, your credit score should be fine. But that doesn’t mean you couldn’t have any unexpected surprises, says Toronto fee-only adviser Jason Heath. He cites the example of a client who was buying a condo and was unaware she had $300 outstanding on a Holt Renfrew card. It took her more than three months to repair her credit rating. While that single infraction wouldn’t have been enough for a bank to deny her a mortgage, it could have resulted in a signi?cant jump in her interest rate.

Moshe Milevsky, an author and finance professor at the Schulich School of Business, says people applying for mortgages should pull their credit scores six to 12 months in advance to make sure there’s nothing wrong. “Get your credit report from all the bureaus,” he advises. Also, try to avoid job volatility for at least six months before applying, as this will make your income appear more stable in the eyes of the banks.

Maximize your down payment

While all home mortgages in Canada require a minimum 5% down payment, paying 20% upfront is one of the single biggest cost-cutting measures a borrower can make. Not only will you owe the bank less principal and interest, but critically you will avoid having to pay Canada Mortgage and Housing Corporation (CMHC) insurance premiums that would add thousands of dollars to your mortgage. CMHC mortgage loan insurance doesn’t protect you—it protects your bank if you default. It’s mandatory in Canada for down payments from 5% to 19.99%. (This insurance can also be purchased through Genworth, a private company.) And the cost is substantial—for instance, if you only put a 5% down payment on a $350,000 home, the CMHC premium will be a hefty $9,144.

If you can’t afford an initial payment of 20%, putting down 10% to 15% will still reap major financial savings. “Those are the insurer breakpoints where insurance fees drop,” says Vancouver mortgage broker Rob McLister. “For example, putting down 10% instead of 9.9% saves you 0.75 percentage points off your entire mortgage amount. That’s $1,500 on a $200,000 mortgage.” For those looking to boost their down payments, the Home Buyers’ Plan is a popular option; it lets you withdraw up to $25,000 in a calendar year from an RRSP to put toward a home you are buying (or building).

One of the best strategies for avoiding mortgage default insurance premiums—and to get into the market sooner—is to buy a house that ?ts your budget. “Sometimes you can’t move into your dream house as quickly as you want,” says Jason Heath. “But with a smaller property you’re that much closer to having that 20% down payment, not to mention money left over.” That was the strategy Anne Langevin, a 43-year-old retail clerk, and her husband Rene, a 42-year-old finance manager, followed back in 1998 when they bought a $210,000 suburban starter home in Mississauga, Ont. “It was just the two of us and the house was reasonable. It wasn’t a huge mansion,” says Anne.

Get the best rate

Prospective home buyers often stick with their own financial institutions when applying for mortgages, but it pays to shop around. Credit unions and non-direct lenders, known as monolenders, will offer a discount—sometimes just a fraction of a percentage point—that will save you money on interest payments compared to larger lenders. For those worried about getting mortgages from more obscure companies, Heath says to remember you’re borrowing, not investing. “The fact it’s a more obscure institution makes it no riskier than a bank. You’ve already got the money.”

Heath recommends scanning the major rate comparison websites—such as Ratesupermarket.ca or Ratehub.ca—to get a general sense of where the market is. Also be sure to ask your lending institution if the interest on your mortgage will be compounded monthly or semi-annually. The less often the interest is compounded the better—semi-annual compounding could save you hundreds of dollars or more in interest.

If you’re not comfortable negotiating on your own, a mortgage broker will do that on your behalf for free. Mortgage brokers are paid a finder’s fee by the lender. There’s no charge for a pre-approval and no obligation. “We’ve always used mortgage brokers,” says Anne Langevin. “When you go into a bank you have to haggle for a lower rate. My husband and I don’t like to haggle.”

Normally variable-rate mortgages are a better deal than ?xed-rate mortgages because you pay a premium for the security of locking into a rate. However, that doesn’t appear to be the case right now, says Jason Heath. “Fixed and variable rates have almost been identical for ?ve years—2.9% on ?xed and 2.8% on variable,” he says. “So, arguably the cost of locking into a ?xed-rate mortgage is so cheap that it’s more compelling to do so.”

Watch the fine print

Securing a low interest rate can shave years off a mortgage, but equally important are the terms of your contract. “Not looking into that and just going by the rate can get you into trouble,” says Calgary mortgage broker Joe Jacobs. For instance, when the Bank of Montreal was the ?rst major lender to drop its ?ve-year lending rate to 2.99% early in 2012, you couldn’t break the mortgage to switch to another lender. “That’s a fairly signi?cant thing,” says Jacobs, “but a lot of clients didn’t know what that was.”

This is where experienced mortgage brokers can make a difference, he says. They will review any restrictions or potential penalties on the mortgage that may end up costing you far more than a small rate difference.

Prepayment privileges also go a long way toward helping pay off a mortgage faster. It may seem unfair, but most mortgages limit your ability to pay off your debt early because the financial institutions will lose the interest revenue that they were expecting. Most mortgages allow borrowers to make annual prepayments of 10% to 20% of principal, without extra fees, with the increased payment amount going directly towards the principal. Just be sure to inquire about the details, as some “no frills” mortgages may prohibit this option. Also be aware that payout penalties—the fees you’ll pay if you break your mortgage early—can sometimes cost tens of thousands of dollars.

The right amortization

Those who want to pay off their mortgages sooner should choose the shortest possible amortization within their financial means, or, as Moshe Milevsky, puts its: “as short as possible until it hurts.” While the typical amortization period is 25 years, it can be as short as 15 years, or as long as 35 years (if you made a down payment of 20% or more on your home). Forcing yourself to pay off the mortgage in fewer years translates into lower interest costs and substantial savings. The major hitch, however, is that your regular payments will be much higher.

To give yourself the best of both worlds, Vancouver mortgage broker Mark Fidgett advises going with a longer amortization, but setting your regular payments higher with prepayment privileges. In effect, you could be paying off a 20-year mortgage in 10 years, but you’d also have the ?exibility to switch back to smaller installments if you were to experience any changes like a job loss or the birth of a child. “That way, you’re in control,” says Fidgett. Your payment schedule can also make a big difference. Payments can be made every month, twice a month, every two weeks or weekly. Going with one of the latter two options is preferable because it will accelerate your payments by an additional two weeks every year. For instance, over a 25-year amortization period on a $350,000 home with a 3% rate you would save more than $18,000 in interest by going with an accelerated biweekly plan.

Prioritize your mortgage

Maximizing your down payment and procuring the best rate and terms possible will save you thousands of dollars. But extra payments will have the biggest impact. To do that, you’ll have to make some tough decisions about your spending and cut out non-essential items, such as family vacations and other luxuries. You may need to stop saving for retirement, depending how serious you are about being free of your mortgage. While that may seem extreme, those who free up their home debt quickly can easily make up for lost investment time later on, provided they funnel cash that previously went to their mortgage into retirement savings.

Remember that paying off debt has the same impact as saving, as both add to your net worth. However, most people’s retirement money is in investments that may or may not gain value, while money paid against the mortgage gives you a guaranteed return by saving you interest.

Nicholas Hui, an auto parts salesman, and his wife Kathy Chan, a law ?rm marketing manager, followed this strategy, paying off their $434,000 mortgage on their Markham, Ont. home in six years. “We didn’t have extravagant lifestyles,” he says. “We didn’t go to Europe or anything.” Instead, they opted for an open mortgage, which has a higher interest rate but no penalty for making extra payments. Several years of sacri?ce and a few $20,000 and $30,000 lump-sum payments helped them meet their goal. These days, they’re quickly catching up on their RRSPs and have started RESPs for their young children—all without the burden of a large mortgage hanging over their heads.

The real key to paying off your home faster is to make sure you get a mortgage that allows you to make extra payments throughout the year and take advantage of them. “That’s the most likely way you’re going to pay off your mortgage a bit quicker,” says Heath. He says borrowers are less likely to make extra payments if they are only allowed to make a single lump-sum contribution on an anniversary date.

Another strategy for paying off your mortgage faster is to increase your regular payments to the maximum allowed without penalty, typically 10% to 15%. Some mortgage contracts also allow borrowers to double their payments. That was one of the strategies Anne and Rene Langevin used to pay off their $210,000 home in less than ?ve years. In addition to making prepayments of 15% to 20% annually, says Anne, “we doubled-up payments whenever we could.”

Paying off your mortgage early isn’t easy, but you’ll thank yourself for it later on. Back in Port Hope, Heidi Croot and Phil Carey are living proof. These days, the couple enjoy living debt-free in their country home, which sits on seven acres of lush property in Ontario’s Northumberland County Forest. Although the two have socked away a nice chunk of money for retirement, Croot still enjoys working part-time to earn additional income—but at a far more relaxed pace. Budget vacations have long since been done away with, too. “We take more expensive ones now,” says Croot. “Africa is on the horizon. We did Maui last November.” All the sacri?ces the couple made years ago to free themselves of mortgage debt have paid off. As Croot puts it, “It’s good to be alive and in the driver’s seat.”

13 comments on “Crush your mortgage

  1. These are good tips (some more theoretical than others). Finding a house in Toronto for under $500K is difficult. A 1.5 bedroom semi just west of the downtown recently sold for approximately $950K. To put 20% down would be $190K plus $19K in closing costs (at 2%). Who has that kind of money for a down payment? Moving an hour out of the city is certainly an option, but not a very good one for many people. Knowing these tips are useful, but don't have much practical implication for people buying homes in Toronto. Even if you could find a house for $450K that's $90K down and $9K closing fees. Meeting the minimum 5% is a more reasonable $22,500 despite the extra insurance costs. Renting sounds nice.

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    • a detached home in toronto can go for more $1 million, i don't think the average person has $200,000, laying around in an account. sometimes it makes sense to go with the 5% route, yes you pay a premium, but you can still follow the other recommendations provided in the article.
      i have some questions that i hope the authors can help me out with you said the insurance company Genworth offers the same service as does CMHC, is it the same rate or different? also is this the method that all the other families that have been profiled this past week used or is there something else missing?

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    • Yeah and if you can’t afford to save 20% down payment on a $1 million house what makes you think you will be able to afford a $950k mortgage?

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    • My spouse & I are 56 & 52 years of age today. We were always fearful of taking on a mortgage (and kept renting all our lives). Finally in 2009 we were Forced to get one – due to new owners of the condo complex (where we have lived since 1995). It was the best thing that could have happened – we realize Now. Today we have a Disabled son (who will likely be living here with us until the day we die). Our goal now is to begin to make extra payments each month to get completely free of any Mortgage within the next five-six years. This will go by quickly. My husband could Retire if he needed to or work part-time then. If we knew what we do now – our mortgage payment is $580/month. Our neighbours have told us for years now – how much they truly regret that they did not buy. Their Rent is now gone up in the past six years – to $1,400/month plus they pay all the utilities also. We NOW realize that the Mortgage is LESS risk to us for sure! Anyone in their 50s right now who is not taking action to be a home owner – will be hitting a financial brick wall the minute they have to retire & do not have their full paycheque – they are worried about this ALL the time. We have neighbours where the husband is now 65 & cannot stop working at all. Plan & think for decades to come – between the age you are now & to when you are 85 & you will be much safer with your OWN roof over your head – being your OWN Landlord! My brother has been doing Divorce Law in Canada for over 35 years now. He said the biggest financial risk is when couples divorce & then do NOT bother to get a mortgage ever again (or cannot qualify on their own) – it is like falling into poverty (think basement suites) for the rest of their days – scary he says. We wish you all the best. A good Mortgage Broker will give you great information & help you figure out how to make it a SAFER future for you too. :)

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  2. very insightful. thank you

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  3. If the "average" person cannot afford $200,000, then the "average" person should probably not be living in Toronto.

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  4. I totally agree here. The incidents happening around us affect everyone and I think housing projects won't be a ticking time bomb if they are low cost homes. Maybe when the economy and its people recover housing projects for the unfortunate will help lessen the hardships people have to go through.

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  5. I'm surprised that the article didn't talk about the one most important step to paying off your mortgage early and that is to not have one at all.

    Before anyone slams the door shut, it is how I did it and paid off my house in 7 years instead of the amortized 15 years.

    It's called the line of credit. All you need is to be able to obtain a line of credit – using the equity in your home – and use that as your only bank account. You pay off your mortgage with your PLC. That way every dime you make goes towards the debt. Your wages go in there, all of your expenses, purchases. The PLC fluctuates, but is primarily drawn down. You would be amazed how quickly the debt is paid. There is no point in having money elsewhere that could be used to pay down debt that you pay interest on.

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    • The line of credit to pay off your mortgage early does not work for most people. Right now a secured credit line runs you 3.50%, a regular variable rate mortgage 2.50%. On a $300k mortgage you save $3k a year on the variable. To generate savings of that amount on the LOC you would have to be carrying an average of $86k in your chequing account which few people do. Then there is that needing to have self discipline thing.

      My experience with people using Manulife One and similar accounts is the balance sits at the credit limit and never moves down. Better for most people to the regular mortgages and and use annual increases in their payments, it does not have to be a lot, to knock years off their amortizations.

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    • the Fella who mentioned using Line of credit to pay off the mortgage, i have seen alot of youtube video on it, and thinking how would it work, lets say i get $10,000 LOC – i put $2000 lumsum before i get my salarary,, so then i owe $2000 on my LOc but did knock off some weeks and intrest of mortgage, so salary comes, goes towards the LOC – now let say i use LOC to paybill and other expense, i am still using LOC, so when would this help ? as i would own on LOC instead of mortgage, ok you say well, there has to be positive cash flow, so after paying expense, u might have $500 left owing on LOc than u make another lumsum of $2000 from loc to mortgage, before salary comes, and then salary goes to LOc – and then u pay expenses, and keep depositing salary in LOC and paying, until u bring your LOc to $500 and then another lumsum – This is what i gather, i need to do, So basically i type this whole thing to explain myself, how would i be doing it. I heard there are software that does it calculation, but i head they charges in thousands… So,, What do you guys think ? should be use bank money to pay bank to cancel their profit on mortgage intrestt,, offcourse we would be paying intrest on LOC – but that calculate monthly ( i think) so as long as salary goes in LOC) ,, balance is 0 owing, until we start usig it for expense.. Who is with me.. Email me, and we will discuss and see if we can come up with game plan, or if someone has that software, please let me know 😀 … email is petergriffinedm @ Gmail . com

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      • Asim, you got the idea. What I did was I had a mortgage and a secured LOC as well. I was allowed to pay 10 % lump sum every year. I would borrow that 5 % to 10% from LOC and pay off the Mortgage. Then over the year all my pay cheque goes into LOC and once its back to 0, I would do it all over again.
        Managed to get my mortgage paid off in 12 years and BTW I did start with 10 % down when I bought my place

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  6. JonJon: “a detached home in Toronto can go for more $1 million, i don’t think the average person has $200,000, laying around in an account. sometimes it makes sense to go with the 5% route, yes you pay a premium, but you can still follow the other recommendations provided in the article.”

    Perhaps if you can’t put 200k down you should NOT be taking out a loan for $950,000 plus CMHC cost of approximately $31,500. Perhaps you should NOT be buying a detached home in such an expensive city. Perhaps look at a 200k home near a GO station and spend the 45 minutes commuting to think about how much money you are saving on interest. Then when you’re done paying off that 200k home you can think about a million dollar home in Toronto using the sale of that house as a down payment.

    That kind of thinking can only be the result of an entitlement complex. If you can’t afford a 200k down payment you are NOT entitled to a million dollar detached home in the heart of the biggest city in Canada. Get a grip on reality and know your worth.

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  7. What about a single person with a mortgage off about $150,000 about what is the estimated time frame off paying off that mortgage living frugal?

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