With all the mortgage talk lately, I decided to blog about getting rid of one! Most home buyers finance their property purchases by a loan which they call a mortgage. The word “mortgage’ literally translates to mort= death and gage= pledge in latin. Death pledge. We typically carry a mortgage that is spread out over 25 – 30 years. That means this debt will haunt you for 25-30 years!! But now it’s even more concerning with interest rates on the rise and cost of inflation going up.
I know the last few years record low interest rates made it stupid to pay off your mortgage quicker when you could invest that money to see a greater return… but now that is not the case. Interest rates are typically only locked in for 1-5 years (unless you did an open mortgage or variable rate mortgage). So, you may not be panicking now to pay down your mortgage, but these strategies I’m going to give you work best over time. If you have a large lump sum, you can put down yearly on your mortgage – that’s great! But I realize that is highly unlikely for the average family. So, here’s some tips to make renewal less shocking when it comes up in 1-5 years. Or tips for those who are paying a higher interest rate and want to avoid paying more interest than principal!
Rates in the last few years were seen as low as 1.39%. Now we are seeing 4.49-5% as normal. Let’s take the average price of a house in Red Deer… around $345,000. Most people put 5% down- so let’s say for illustration purposes that Family A has a mortgage of $340,860 (after down payment & mortgage insurance) and Family B also has a mortgage of $340,860. We will use an interest rate of 4.40% over a 5 year term.
Makes a monthly payment of $1875.32 and makes no pre-payments. (Pre-payments are described as extra payments you put towards your mortgage other than your monthly minimum). At the end of the 5-year term, Family A has paid $70,626 in interest. Ouch!!
Has decided to round up their mortgage payment by 20% per month. Also, instead of doing the regular monthly payments they have decided to do bi-weekly accelerated payments which a payment every two weeks(adding a few extra payments a year). By doing this, Family B has shortened their 25 year mortgage to 16.35 years and they ended up saving over $3721 in interest in 5 years. But over $51,139 in interest had they done regular payments for 25 years! That’s quite a chunk for only $187 extra every two weeks. And two extra payments a year (accelerated bi-weekly).
Now let’s say for illustration purposes that Family C did everything that Family B did PLUS added their income tax return at the end of the year. We will pretend that Family C got a return of $2000 each year. Family C would have paid their mortgage off in 15 years and saved $63,843 in interest! Amazing!
Let’s say after 5 years each family decided they want to sell their house and move onto something else…. let’s say their houses are worth the same just for illustration purposes. This is how much equity (positive cash) each family would have before considering real estate commissions, legal fees, etc:
- Family A $345,000 - $298,967 (balance owing on mortgage) = $46,033
- Family B $345,000 - $261,127 (balance owing on mortgage) = $83,873
- Family C $345,000 - $250,188 (balance owing on mortgage) = $94,812
This shows how powerful small changes can be. Another reason you should pay off your mortgage sooner is because interest rates can rise. A hike in interest can be detrimental to paying down your mortgage. This isn’t something we can predict or control therefore the more we pay down the better it will be. Then, when it’s time to renew your mortgage, you don’t have to fear interest changes.
Example, let’s say these 3 families stayed and their interest rate went up to 5.50% upon renewal.
Family A mortgage payment would go from: $1875.32 per month to: $2056.56 per month but had they did what Family B or C did, they could have payments as low as: $1796.26 (Family B monthly upon renewal with no extra pre-payments) or as low as $1721.01 like Family C. —
Here are some tips on how you can pay off your mortgage faster: Here are some tips on how you can pay off your mortgage faster:
More frequent payments
Switch from monthly payments to bi-weekly or weekly accelerated payments.
If your mortgage payment is an odd number such as $1411, perhaps round up to the nearest hundredth like $1500 or if you really want to get saving, $1600. Most lenders allow 20% prepayment lump sum each year and/or 20% increase of your mortgage payment. Check with your lender first.
Use any unexpected amounts of cash you receive towards your mortgage. For example, income tax refund, inheritance, promotion at work, gifts, bonuses at work. Most lenders will allow you to pay up to 20-25% of your mortgage prior to your term ending. RRSP’s Depending on your circumstances, maybe it’s not a bad idea to increase your mortgage payments instead of contributing to an RRSP;s. Or simply use the income tax refund at the end of the year as a lump sum.
While I understand Roommates may not be convenient for everyone- some home owners find it a great way to increase income and pay off the mortgage faster. Rooms can rent anywhere from $300-$800 a month!
With all this being said, the fact you have a mortgage, and you aren’t paying rent anymore is really great thing. You can see how over the years the equity does build up quite quickly. However, we get lost in that idea and don’t realize how a few small changes can really make a big difference. Nobody wants to be paying debt off forever! And for those of you who already do these things- thumbs up! If you have any questions in regard to the financial side of things- please contact me today and I can recommend an appropriate mortgage broker, financial coach, financial advisor or bank associate to cater to your needs.
Disclaimer* please seek professional financial advice. This is merely an observation and should not be considered advice or counsel.