Many homeowners choose the default option to make their mortgage payments once a month. However, accelerated mortgage payments may be an appealing alternative for borrowers looking to reduce their total loan costs and become debt-free sooner.
When you increase the frequency of your mortgage payments, you put more money toward your principal mortgage balance, allowing you to pay off your loan faster and reduce your overall interest expenses.
“Even though interest rates are super low right now, most people do have a goal of paying off their mortgage,” says Shawn Stillman, principal broker at Mortgage Outlet. “By setting up accelerated payments you’re definitely doing the right thing.”
However, before you rush to make those extra payments, there are pros and cons to consider. Let’s look at what you need to know.
Regular vs. accelerated payments: what’s the difference?
Depending on the terms of your mortgage loan, you can choose a more frequent payment schedule than monthly.
The difference is that you’ll make approximately one additional payment per year with accelerated payments.
Making accelerated payments will cost you a little more upfront each month, but will reduce the amount of interest that accumulates by paying down the principal faster. Because interest is calculated on the principal balance, the amount of interest payable decreases as the principal balance decreases.
Most lenders will offer borrowers six different mortgage payment options:
- Monthly (one payment per month, 12 times a year.)
- Bi-monthly (half your monthly payment, twice each month, 24 times a year.)
- Bi-weekly (a payment every two weeks, 26 times a year.)
- Rapid bi-weekly (half your monthly payment, every two weeks, 26 times a year.)
- Weekly (a payment every week, 52 times a year.)
- Rapid weekly (a slightly higher payment every week, 52 times a year.)
Stillman says it may not sound like much, but accelerated payments will save you thousands of dollars in interest in the long run. Opting for bi-weekly payments instead of monthly payments can shave about two-and-a-half years off the average 25-year mortgage, while weekly payments can help you pare down your mortgage even faster.
For instance, if you took out a mortgage for $300,000 with a 25-year amortization on a fixed five-year term at a 5% interest rate, your monthly payment would be about $1,745 per month.
If you changed your payment frequency to bi-weekly payments, you would pay about $805 every two weeks, amounting to 26 payments over the course of a year. This would save you about $2,872 in interest charges over the course of your mortgage. Change that to accelerated or rapid bi-weekly payments — which would still see you make 26 payments per year but at a slightly higher amount of roughly $872 each time — and you would save about $37,560 over the course of your mortgage.
What to consider before you try accelerated mortgage payments
While most Canadians dream of being mortgage-free, the reality is that if you have additional money to spend each month, it might be put to better use somewhere other than your mortgage payment.
For instance, given the current record low-interest rates, you might be able to save enough to finance your next real estate purchase, or you could be able to invest the extra money in the stock market, which can yield an average annual return of between 4.5% and 6.5%.
Keep in mind that accelerated payments are not available from all lenders. So before you take a mortgage, make sure to ask your lender if they do.
Also, before you try to make any extra payments, Stillman warns homeowners to carefully read their mortgage contract to make sure they know the specifics of the penalties involved, if any.
While some lenders may let you change the frequency and amount of your mortgage payments without penalty, others will charge you a fee. This is why, while negotiating your mortgage contract, you should think about prepayment privileges and payment flexibility with your lenders from the start.
In weighing whether or not to make accelerated payments, Stillman suggests you consider the pros and cons and ask yourself if you have the financial flexibility to pay down your mortgage while still working toward other financial goals.
“Look at the difference in numbers between accelerated and non-accelerated,” he says.
“Do you have a better use for this money? If you’re going to put that $100 [a month] toward RRSPs or a Tax-Free Savings Account then I think that's a great idea, because building up other assets is definitely worthwhile. If you're going to spend it on Starbucks, it's probably not such a good idea.”