Drop mortgage debt
A few simple things can dramatically reduce mortgage costs, so ask your adviser about long-term goals and future plans
The prospect of a mortgage and owing a huge sum over decades — whether you’re arranging or renewing financing on a home — can be daunting. And when you look at how much of your payments go toward the interest in the early years of your mortgage, that’s even more discouraging.
But you can dramatically reduce the amount of interest you’ll pay over the life of your mortgage by doing a few simple things, such as making bi-weekly payments, or exercising your prepay- ment options.
Before you sit down with your mortgage specialist, you should consider how long a term you want and how long an amortization you are seeking. The term — generally one to 10 years — is the length of time you are committed to a mortgage rate, lender and that lender’s conditions. Amortization is the length of time it will take to pay off the mortgage in full (generally 25 years).
Jared Ksenica, BMO’s regional vicepresident for the GTA mortgage
specialist sales force, says when he first sits down with clients, he assesses their risk tolerance, their view on rates and asks questions about their longterm goals and how long they plan to stay in their house.
“People will often ask me for a 25- to 30-year mortgage,” says Ksenica. “But maybe a 22-year mortgage is more suitable based on your next stage of life, if you have kids going away to school or are retiring. You are able to customize your mortgage and tie it into your life plans.”
While a long amortization may have smaller payments than a shorter amortization, it will also cost much more to borrow.
When it comes to the mortgage term, consider that people usually move within five years; 3.5 years is the usual range of first-time buyers and young borrowers. If you plan to move in a few years, a five-year term may not make sense since you’ll have to pay a penalty to “break” your mortgage before its term is over. That penalty could be three months interest or the difference between your rate and the prevailing rate.
However, if you are buying another house and stay with the same lender, you can often transfer your balance and term to avoid penalty. If you need a larger mortgage, the old rate with your existing mortgage will be blended with current interest rates on the new mortgage amount.
One of the simplest ways to whittle away your mortgage balance is by making accelerated bi-weekly payments. By paying every other week (26 times a year) rather than monthly, you are making the equivalent of one month’s extra payment during each calendar year, says Ksenica. “You can knock four years off a 25-year mortgage by doing bi-weekly payments. It’s not painful and I suggest to people when setting it up, to try to get the mortgage payments to coincide with your pay dates to make it easier to budget.”
Take a $250,000 mortgage with a 25-year amortization as an example, with an interest rate of 3.69 per cent (BMO’s current fixed five-year rate). If you make the monthly payment of $1,273.38, over 25 years you will pay $165,105 in interest — $415,105 in total for principal and interest.
If, instead, you make accelerated bi-weekly payments, you will pay $636.69 every other week. Over 25 years, you will pay $90,362 in interest, saving you $50,985.
And if you opt for a 20-year rather than 25-year amortization and make bi-weekly payments, the savings are even more dramatic: you’ll save $74,743 in interest.
Ask your mortgage expert what prepayment options you have as another way to whittle down your debt. For example, many institutions such as BMO allow homeowners to pay off up to 20 per cent of their original mortgage amount per calendar year.
Another prepayment option is to increase the amount of your payments — you can usually increase your payments by up to 20 per cent a year, in addition to being able to pay off 20 per cent.
“The main thing I recommend is to treat your mortgage like you would a visit to your doctor or dentist,” says Ksenica. “Make it a point to come into your financial institution once a year, so see what options are available, what the new features are and where the rates are at.”