Buying a home is a big investment and a huge commitment, but most homeowners will attest that the pay-off is worth the pains and strains of making those regular mortgage payments. Most people focus on their mortgage interest rate as a way of saving money (or at least, ensuring more of it goes toward your principal), but there are other ways to decrease the amount paid in interest. One way is to pay your mortgage off faster. More on that below, but let’s start with a basic mortgage 101.
What is a mortgage?
In order to buy a home in Canada, you’ll need a down payment of at least five per cent of the home’s purchase price (but it can be more). These funds are typically saved over time and can be boosted with the help of programs such as the first-time Home Buyer’s Plan (HBP) and the new(ish) First Time Home Buyer Incentive, administered by the federal government. The remaining amount owing on the home is borrowed in the form of a mortgage loan. This loan is amortized over a number of years (commonly 25 years for first-time homebuyers) with mortgage terms and an interest rate that are renegotiated after a given period of time (commonly five years, but the term can range anywhere from 6 months to 10 years). The total amount borrowed is divided up as monthly or bi-weekly payments over the amortization period.
How your mortgage rate impacts the price you pay
A portion of every payment you make goes toward paying down the principal loan (the final purchase price of the home) and a percentage of it will go to the lender as an interest payment on your loan. The higher your interest rate, the more money goes to the lender versus to paying down your principal loan. When all is said and done, it’s in the homebuyer’s best interest to secure a mortgage loan at the lowest possible rate.
Some homebuyers choose to go with a variable rate mortgage, which fluctuates based on the prime lending rate.
Why should you pay off your mortgage faster?
Aside from the interest rate, your amortization period also impacts the amount you’ll pay in interest over the life of your mortgage. Stretching your mortgage out over a longer term will decrease the amount of each mortgage payment (which can help with day-to-day expenses) but doing this will also lengthen the time it will take to pay off the loan (obviously) and increase your total interest paid. Depending on the amount of the mortgage loan and your interest rate, this translates to a considerable sum of your heard-earned, harder-saved money going to the lender instead of building your home equity.
With every mortgage payment you make, you increase your home equity, decrease the borrowed amount and thus, decrease the amount you pay in interest.
How do you pay off your mortgage faster?
To put this simply, the faster you whittle away at the amount you owe, the less you’ll pay in the long run. Here are 8 tips to pay your mortgage off faster, from our friends at DebtReviews.com:
#8 Pay More
It’s an obvious solution, yet the majority of debtors just don’t do it. They would rather have a few extra hundred dollars in their pocket than the knowledge that they can save thousands over the course of their mortgage.
But the figures are hard to ignore. For example, if you have $250,000 left on a 25-year mortgage and you pay an extra $500 a month, you could save yourself over $65,000 and reduce the term of your mortgage to just 15 years.
This applies to any additional payments that you can make. An extra $50 a month in the above scenario will only reduce your term by just under 2 years, but it will also save you over $10,000. A good way of looking at it is that every additional payment you make will increase the value of all following payments by ensuring that a higher percentage goes towards the house and not the debt.
#7 Pay Your Other Debts First
It may sound counterintuitive based on what we said above, but one of the easiest ways to pay off your mortgage is to clear your other debts first. A mortgage is a long-term debt with a relatively small interest rate. Credit cards and personal loans, on the other hand, are short-term debts with huge interest rates.
You may save more money in the long-term by focusing on your mortgage, but a credit card or personal loan debt will do much more damage in the short-term. The payments are typically harder to meet, the penalties are very severe, and if you do struggle and those debts are prolonged, they will be considerably more damaging than a mortgage.
Your first priority should be to pay off any loans or credit cards that have accrued penalties or have otherwise high interest rates. The money you save by not paying interest on these debts can then be used to increase your mortgage repayments.
#6 Pay Bi-Weekly Instead of Monthly
This may seem like a strange tip, but it’s an effective one nonetheless. There are 12 months in a year but 26 bi-weekly cycles. If you convert your monthly payments to bi-weekly payments, paying 50% each time, you’ll essentially be making one extra repayment every year.
Of course, this is no magic trick and you’ll still be paying more, but it’s a great option for debtors who crave order and structure and are looking to pay a little extra money every year. This is not something that lenders offer, so you need to take the time to deposit money into your account every two weeks and then give that money to the lender at the end of the month. If you do this throughout the year then you’ll have enough to make a double payment by the end of the year.
#5 Pay Lump Sums
You don’t need to agree to additional monthly repayments just to clear more of your debt. You can also pay lump-sum amounts whenever you have the money to do so. Again, it can be difficult to find the willpower to give up a sizeable sum of cash with the knowledge that you won’t see the benefits for years to come, but it’s just a case of adopting the right attitude.
You have to understand that a significant portion of every repayment you make is being used to pay interest, as opposed to the principle. But once that repayment has covered the interest then you can attack the principle and start actually paying for the house. So, if you get an unexpected windfall, consider using it to pay off your mortgage and you could save yourself a small fortune over the long haul.
#4 Rent Out Your Home
If you have a spare bedroom, garage, basement or attic space that you’re not using then consider renting it out. Property is at a premium these days, and in many cities you won’t need to wait long to find a willing tenant.
If you have had your mortgage for a few years and you’re not happy with it, your financial situation has changed or you simply want a new approach, then it is time to refinance. You may be able to negotiate a better interest rate, especially if you are willing to pay some money upfront or agree to higher monthly repayments.
#2 Spend Less
There are a number of ways that you can reduce your household expenditure, before using all of the money that you save to pay off more of your mortgage. Over the course of a year the average American spends $500 on food they end up throwing away; $1,000 at coffee shops; $3,000 eating out; and several hundred dollars on bottled water.
If you tighten your purse strings even just a little, you’ll have more money in your pocket at the end of each month.
If you’re sitting in your home right now, take a look around you. Of all the things you see, how many do you actually use and need? If you’re like the average Canadian there will be piles of CDs and DVDs that are no longer listened to or watched; stacks of video games that were cast aside as soon as the next must-have title was released; closets full of clothing that’s too big or small; old phones and computers.
What about the guitar you promised you’d learn but haven’t touched for years, the telescope/camera you bought before you lost interest, or the stack of textbooks from your last college course?
The average home contains an abundance of junk just begging to be sold. And with the advent of apps that let you list your items for sale online, there’s no excuse not to sell-up.