Mortgage Blog

Prepaying your mortgage is one of the most effective strategies for reducing interest costs and shortening the time to become mortgage-free. To make the most of this option, it's crucial to understand the prepayment privileges and potential penalties outlined in your mortgage contract. By doing so, you can avoid costly errors and develop a sound mortgage plan.

In this comprehensive guide, we’ll walk you through the ins and outs of mortgage prepayment in Canada, explaining how it works, the options available to you, and ways to maximize your savings.

Key Points:

• Prepaying your mortgage allows you to reduce interest costs and shorten the mortgage term.
• Most mortgages offer prepayment privileges such as lump-sum payments, increased regular payments, and accelerated payment frequencies.
• Exceeding your annual prepayment limits can lead to penalties, so it’s essential to know your contract terms.

What Is Mortgage Prepayment?

Accelerating your mortgage payments is an excellent way to cut down on the interest you pay over time and become mortgage-free faster. When you opt for an accelerated payment schedule—such as weekly or biweekly payments—you’re paying more toward your mortgage annually, not just splitting monthly payments into smaller amounts.

For example, with an accelerated biweekly payment schedule, you make 26 payments annually (the equivalent of 13 monthly payments), which reduces your principal faster and decreases the total interest over the life of the loan. This method is especially effective for variable-rate and adjustable mortgages, which compound more frequently than fixed-rate mortgages.

Beyond financial savings, faster mortgage repayment also helps you build equity more quickly, which is particularly beneficial if you plan to sell or refinance your property in the future. It’s a smart approach for homeowners who want to pay down their mortgage without making large lump-sum payments or stretching their budget.

Maximizing Your Savings with Mortgage Prepayment Calculators

A mortgage prepayment calculator is an invaluable tool for homeowners looking to understand how additional payments impact their mortgage. These calculators allow you to test different scenarios, such as lump-sum payments or increasing regular payments, and instantly show you the effect on your mortgage’s amortization period and total interest costs.

You can enter details like your mortgage balance, interest rate, and payment schedule, and then experiment with various prepayment amounts. This gives you a clear picture of how much time and interest you can save. Some calculators also include prepayment penalty estimations, which can help you avoid overstepping your lender’s limits.

Prepayment Options in Canada

There are several ways Canadian homeowners can make extra payments toward their mortgage:

1. Lump-Sum Payments: These one-time payments directly reduce the principal balance of your mortgage. Most lenders allow lump sums up to 10-20% of the original principal annually without penalties.

2. Increase Regular Payments: By increasing your regular payments, even slightly, you can significantly reduce the interest owed over time. Be sure to stay within your lender’s annual limits to avoid penalties.

3. Rounding Up Payments: A small change, such as rounding your payments from $1,576 to $1,600, directs more money toward the principal, helping you save on interest and pay off the loan faster.

4. Accelerated Payments: Opting for more frequent payments, such as weekly or biweekly schedules, allows you to make one extra payment per year. This small adjustment can lead to substantial savings by shortening your mortgage term and reducing interest.

Understanding Prepayment Penalties

If you exceed your lender’s prepayment limits or break your mortgage early, prepayment penalties may apply. These penalties compensate lenders for the lost interest they would have earned if you stuck to the original payment schedule.

For closed variable-rate mortgages, the penalty is typically three months' interest. For closed fixed-rate mortgages, the greater of three months' interest or the Interest Rate Differential (IRD) applies. The IRD compares your current mortgage rate to your lender’s rate for a similar term, making it crucial to understand how it’s calculated, especially if you received a discounted rate.

How to Avoid Prepayment Penalties

To avoid penalties, stay within your contract’s prepayment privileges. If you expect to make larger payments, consider choosing a lender with higher prepayment allowances or opt for an open mortgage, which offers unlimited prepayments in exchange for higher interest rates.

By understanding these options and using tools like mortgage calculators, you can create a personalized strategy to pay off your mortgage faster and save on interest—without incurring unnecessary costs.