Excerpt: “Burn Your Mortgage” Chapter 11
Chapter 11: Making the Most of Your Mortgage Payments
Chapter 11: Making the Most of Your Mortgage Payments
Have you ever wondered what the origin of the word mortgage is? The English word comes from the French mort-gage, which translates as “death-pledge.” French peasants literally worked them- selves to death to own a home. (Boy, they weren’t kidding about a mortgage being a life sentence!)
Your mortgage may seem like a death pledge, but it doesn’t have to be. In the previous chapter you learned everything you needed to know to find the best mortgage for you. In this chapter you’ll learn what you need to know to pay it off, so that you can have a mort- gage-burning party of your own.
Seven Simple Ways to Pay Down Your Mortgage Sooner
This is the moment you’ve all been waiting for. Below you’ll find simple ways to burn your mortgage. To make things easier, we’ll use the same fictional mortgage in each example discussed below. So, imagine you’re buying a condo for $375,000 with a 20% down payment
($75,000), leaving you with a $300,000 mortgage. Like most Canadians, you go with the safety of a five-year fixed-rate mortgage at 2.99%. Instead of monthly, you choose to pay your mortgage accelerated biweekly.
There’s a common misconception about payment frequency. Many people think that how often they make a mortgage payment plays a larger role in interest savings than it actually does (in fact, it plays a small role.) It’s the accelerated alternatives that save you the big bucks. When you pay weekly (52 payments per year) or biweekly (26 payments per year) instead of monthly (12 payments per year), the interest savings are minimal; in these scenarios, it’s more about find- ing the payment frequency that best matches your cash flow. With accelerated weekly (52 payments per year) and biweekly (26 payments per year), you’re paying the equivalent of an extra month’s payment every year (more on this below).
At first glance, you’re probably wondering how you’re saving any interest with accelerated weekly or biweekly. After all, you’re still making the same number of payments as non-accelerated weekly and biweekly. While that may be true, you’re actually paying a slightly higher amount on each mortgage payment. To understand this, it helps to look at the difference in the way biweekly and accel- erated biweekly are calculated.
If your monthly mortgage payment is $1,418 and you pay biweekly, your biweekly payment is $654 ($1,418 × 12 months/26 weeks = $654). But when you pay accelerated biweekly, your biweekly payment is slightly higher, at $709 ($1,418 × 12 months/24 weeks = $709). As mentioned, with accelerated weekly and biweekly, you’re paying the equivalent of 13 monthly mortgage payments instead of only 12. Paying accelerated on a biweekly schedule that matches your pay- day is the most painless way to budget for the higher payment. You won’t even realize you’re making higher annual payments (it’s probably a good thing, as you might not choose this option if you did).
EXAMPLE: ACCELERATE YOUR MORTGAGE PAYMENTS AND SAVE BIG BUCKS
Accelerating your mortgage payments can make a big difference com- pared with regular (i.e., non-accelerated) payment frequency. As the chart below shows, by paying your mortgage accelerated biweekly instead of monthly, you can save over $15,000 in interest and pay off your mortgage almost three years sooner.
|Payment frequency||Payment amount ($)||Total interest paid ($)||Interest saved ($)||Years to mortgage freedom|
Make lump-sum payments whenever you can afford to (most lend- ers let you do this on one of your regular payment dates during each year of the mortgage term) by tossing “found” money—tax refunds, bonuses, cash gifts—at your mortgage. Look for new ways to save money: brownbag your lunch, switch to a less expensive cell-phone plan or carpool, and put the money you save toward a lump-sum pay- ment on your mortgage. Lump-sum payments go straight toward principal, saving thousands of dollars in interest and shaving years off your mortgage amortization. For example, if you take your $2,000 bonus at work and make a lump-sum payment each year with it, you’ll save $17,774 in interest and pay off your mortgage in only 19 years—6 years sooner.
By shortening your amortization period—the length of time it takes to fully repay the mortgage—your mortgage payment will be higher, but you can save a ton in interest. Try shortening your amortization period from 25 years to 20 years. In the same example, by paying your mortgage in 20 years instead of 25 years, not only will you pay off you mortgage 5 years sooner, you’ll save $22,891 in interest.
That being said, to give yourself more flexibility, you might consider going with a longer amortization period and taking full advantage of your prepayment privileges. That way, if you lose your job, say, you won’t be stuck paying the higher mortgage payment. At the time of writing, the maximum amorti- zation for a high-ratio mortgage is 25 years, and 30 years for a conventional mortgage.
Round up your mortgage payments to the closest $25 payment increment, so you’re paying a few extra dollars a month toward your mortgage. By rounding $709 paid accelerated biweekly up to $725—$16 more (about the price of a couple of beers at happy hour)—you’ll save $3,697 in interest and pay off your mortgage in just less than 22 years—3 years sooner. Get in the good habit of increasing your mort- gage payment whenever you get a raise at work or land a lucrative long-term contract.
Don’t Get Dinged with NSF Charges
Keep track of money coming out of your chequing account for mortgage prepayments. Consider making purchases on your credit card instead of your debit card so you don’t have to worry about your bank account balance before each purchase (that being said, be careful not to carry a balance on your credit card, as the interest is costly).
By increasing your mortgage payment as if rates are 2% or 3% higher than they are, not only will you pay your mortgage off sooner, you’ll be prepared if mortgages rates are higher when your mortgage comes up for renewal. If you pay your mortgage as if rates are 4.99% (i.e., 2% higher), your biweekly accelerated payments will increase from $709 to $872. Although your payments would be $163 more, you’d save $28,719 in interest and pay off your mortgage in less than 17 years.
If mortgage rates are a lot lower today than they were when you signed up for your mortgage, it may be worth refinancing it. When you refinance your mortgage, you’re breaking your existing mort- gage to sign up for a new mortgage at a lower rate. This often comes with penalties and fees (see Standard vs. Collateral Charge, p. 136 ). To come out ahead, your savings from refinancing have to outweigh the penalties (see the example in chapter 10, Penalties: Breaking a Mortgage Doesn’t Come Cheap). Before you break your mortgage, get your mortgage broker to crunch the numbers, or use an online mortgage-penalty calculator to make sure it makes sense to do so (your mortgage penalty could end up being higher than you think). To reduce the mortgage penalty, prepay as much of the mortgage as you can before breaking it. To save even more interest, when you refinance, keep paying the same mort- gage payment you were paying at the previous higher rate. As for fees, ask your new lender to see if they’ll cover them.
Contributing to an RRSP vs. Paying Down Your Mortgage
There’s a never-ending debate about whether it’s better to pay down your mortgage or con- tribute to an RRSP. Keep things simple. Contributing to an RRSP doesn’t make sense for everyone (e.g., if you expect your tax rate to be higher in retirement than it is now), but for those for whom it does, contribute to it and use the tax refund as a lump-sum payment on your mortgage.
I wouldn’t have paid off my mortgage in three years by age 30 if I hadn’t set a mortgage-free date. It all comes down to goal setting. I’m a sci-fi nerd, so I wanted to pay off my mortgage before Star Wars: The Force Awakens hit theatres. I’m not ashamed to admit I had a Star Wars countdown clock on Facebook—every morning I’d wake up to see how many days were left until the movie’s release. This helped motivate me to keep going. Circle the date of your mortgage-burning party on the calendar (and complete the worksheet below), and do what it takes to pay off your mortgage early (heck, send out invitations early if that’s going to motivate you!). Imagine how amazing it will be to celebrate burning your mortgage with all your family and friends cheering you on.
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