Buying a home is a big investment and a huge commitment, but most homeowners will attest that the long-term pay-off is worth the shorter-term financial pains and strains. Over the last few years, mortgage interest rates have been in the spotlight, and more recently, the culprit behind many of those “pains and strains.” A higher interest rate means the cost of borrowing is more expensive, including car and student loans, lines of credit, outstanding credit card balances, and mortgages. But what if we were to tell you that there are ways to lighten the load of your mortgage burden?
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 or more of the home’s purchase price. 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).
The remaining amount required to purchase the home is then borrowed in the form of a mortgage loan. This loan is amortized over a number of years (commonly 25 years for first-time homebuyers) under specified terms and an interest rate that are renegotiated after a given period of time (commonly five years, but the term can range from 6 months to 10 years). The total amount borrowed is divided up into regular payments (monthly or bi-weekly) 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 eight ways to help pay your mortgage off faster:
Increase your mortgage payments.
Yep, this is 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 two 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 toward the house and not the debt.
Pay your other debts first.
It may sound counterintuitive based on the advice 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 low interest rate. Credit cards and personal loans, on the other hand, are shorter-term debts with higher 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 carrying 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.
Make bi-weekly mortgage payments instead of monthly.
This may sounds 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 per cent each time, you’ll essentially be making one extra payment 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. And in all honesty, you likely won’t even miss it.
Make lump-sum payments.
You don’t need to agree to additional monthly repayments just to clear more of your debt. You can also potentially pay lump-sum amounts whenever you have the money to do so, provided your mortgage terms allow for it. 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.
Use part of your home as an income property.
Renting out part of your home is a great way to boost your income and help chip away at your mortgage on a regular basis. If you have a spare bedroom, garage, basement or attic space that you’re not using, 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. Laneway homes have also gained popularity in recent years as a solution to the housing shortage.
Refinance your mortgage.
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.
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.
Sell up.
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? 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.
