Paying Off Your Mortgage

This Page's Content Was Last Updated: May 11, 2022
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What You Should Know

  • While investing in a rental property will earn you a higher ROI, it comes with more stress.
  • An open mortgage allows you to fully pay off your mortgage without penalties.
  • A closed mortgage only lets you prepay 20% of the principal each year.
  • There are different tactics to avoid penalties depending on if your term ends.

Paying off your mortgage allows you to live debt-free, which can be a relief as you approach retirement. You will no longer need to make monthly mortgage payments and have extra money to travel or pursue new hobbies. However, completely paying off your mortgage may not be the best decision. The first section will compare alternatives to paying off your mortgage. If you still decide a debt-free lifestyle is paramount, the section part will teach you strategies to pay off your mortgage faster.

The second section is further divided into two parts which explain the best ways to pay off your mortgage before and after your term ends. These strategies will save you significant mortgage prepayment penalties. Continue reading to become an expert in paying off your mortgage in five minutes or less!

Paying Off Your Mortgage or Investing

While paying off your mortgage will remove your most significant debt, it's not the best strategy to increase your net worth. If you are sitting on a chunk of cash, investing in a rental property will likely provide you with a higher return on investment.

Paying Off Your MortgageReal Estate Investing
Pros
  • Peace of mind
  • Save on mortgage interest
  • Guaranteed savings
  • Higher return on investment
  • Something to do in retirement
  • Creating generational wealth
Cons
  • Can be prepayment penalties
    if approached incorrectly
  • Can make a higher return on
    investment through rental properties
  • Stress of property management
  • No guaranteed return on investment

You will have two properties that appreciate. Additionally, the rent your tenant pays should cover the costs of your new property and provide you with some additional cash flow. Each payment your tenant makes will contribute to your mortgage amount, meaning you'll build home equity ownership in the rental property. However, you will have to deal with the stress of managing two properties. This can include evicting a tenant, property repairs, and managing tax reporting.

The following table compares a hypothetical five-year return on investment between prepaying the final five years of your mortgage or choosing to contribute the money to a second property down payment instead.

Paying Off Your MortgageInvesting
Initial Investment$100,000$100,000
Interest Saved$9,516N/A
Net Rental Income ReceivedN/A$67,500
5-Year Property Appreciation$270,580$422,782
Total Savings/ Income$280,096$490,282
5-Year Return on Investment180%390%
Assumes current value of primary home at $800,000 and investment property at $450,000. Remaining mortgage principal is $100,000 with a 3.5% interest rate. There are no prepayment penalties. Rental property has a cap rate of 3%. Both properties experience a 6% annual property appreciation over the five years. Note that investing provides you with double appreciation because you own two properties.

Tactics to Pay Off Your Mortgage Faster

If you decide the stress of being a landlord is not suitable for you, there are many ways to pay off your mortgage. Your approach to paying it off depends on if you have an open or closed mortgage. An open mortgage allows you to prepay an unlimited amount of your mortgage in exchange for a higher interest rate. A closed mortgage lets you pay no more than 20% of the principal every year. If you prepay more than 20% in a year with a closed mortgage, there will be prepayment penalties which can cost you thousands of dollars.

Your mortgage contract will specify your prepayment privileges; otherwise, you can talk with your lending representative. If you have an open mortgage, paying it off will be as simple as one lump-sum settlement. However, most Canadians have a closed mortgage which makes paying off your mortgage more challenging. The following section explains the best strategies to pay off your closed mortgage while avoiding penalties. This section is broken into two parts that present the best strategies for beginning to pay off your mortgage now or waiting for your term to end.

Part A: Paying Off Your Mortgage Before Your Term Ends

Annual Lump Sum Payment

Almost all mortgage lenders in Canada allow you to make a lump-sum payment each year without penalties. This approach is great if you receive an annual bonus or inherit some money. The payment typically can't exceed 20% of your mortgage principal. For example, if you have a remaining principal of $100,000 on your mortgage, you can prepay up to $20,000 this year. Lump-sum payments will let you pay off your mortgage faster if you choose to keep similar or increased monthly mortgage payments in your next term.

It's essential to note the difference between your mortgage balance and principal. The balance includes the interest owed, so it will always be a larger number. The principal is what you owe before interest. You can determine the difference between the two by looking at your mortgage amortization schedule.

Switch to Bi-Weekly Payments

If your income has increased, you can pay off your mortgage faster by making smaller bi-weekly payments. Instead of making monthly mortgage payments, you can switch to accelerated bi-weekly payments. This means you make 26 payments throughout the year instead of 24. For example, if your monthly mortgage payment is $1,000, your accelerated bi-weekly payments will be $500.

You make one extra monthly payment each year without noticing a difference in your wallet. The best part is that there are no prepayment penalties for doing this. If you want to switch to accelerated bi-weekly payments, you must contact your mortgage lender and request the change. The disadvantage of this method is that your cash flow will be more sporadic. This can strain your monthly budget if you're not used to making regular payments.

Increase Monthly Payment

You can also request to increase your current monthly mortgage payments. Most lenders will allow you to make an additional lump-sum payment or increase your regular monthly payments up to 20% without any penalties. For example, if your monthly mortgage payment is $1,000, you can increase it to $1,200 per month. Additionally, most mortgage lenders will allow you to make a double mortgage payment once per year.

This method is excellent if you receive a significant pay raise. The increased payments will help you pay off your mortgage faster and save on interest costs. Be sure you're comfortable making the larger monthly payment before increasing it. You don't want to strain your monthly budget and default on your mortgage.

Downsize Your Home

Moving to a less expensive home will enable you to free up home equity which can then be used to pay off your mortgage. If you have a $100,000 mortgage and sell your home for $300,000, you'll have $200,000 in home equity. You can port your mortgage to another home without penalties.

While this method will free up cash, there may be restrictions to pay off your mortgage. If you have a closed mortgage, you'll have to pay it off through annual lump sums and increased payments with a bi-weekly frequency. There are penalties for prepaying more than 20% of your mortgage balance with a closed mortgage. By combining these tactics, you can avoid the penalties while still aggressively paying off your mortgage. If this sounds like a headache, you may prefer waiting for your term to end before using the cash to pay off your mortgage fully.

WOWA Tip: Mortgage Term Explained

Most Canadians have a mortgage term of five years. This is an agreement with your mortgage lender on your mortgage interest rate and other specific mortgage details. For example, your term contract will also mention whether the mortgage is open or closed, fixed or variable, and more. These details are valid throughout your term length. If you switch lenders before your term is over, there will be penalties. It can be better to wait for your term to end before paying off your mortgage. The following options explain strategies for paying off your mortgage when your term ends.

Part B: Paying Off Your Mortgage After Your Term Ends

Make a Large Lump-Sum Payment

You can make a lump-sum payment when your term matures without any penalties. This can be a great way to use any extra money you have saved. For example, if you have a $100,000 mortgage with a five-year term, you can pay off the entire mortgage when the term expires without any penalties. This is different from the annual lump-sum payment, which only allows you to prepay 20% each year. You can contribute any amount you want and don’t need to fully pay off your mortgage. This lump-sum payment will save you significant interest costs and help you become debt-free sooner.

Refinance Your Mortgage

If you don't have the money to make a lump-sum payment, you can also pay off your mortgage faster by refinancing to a shorter term. For example, if you have a $100,000 mortgage with a five-year term, you can refinance to a new three-year term. This will increase your monthly payments, but you'll pay your mortgage faster.

Just be sure to shop around for the best mortgage rate before refinancing. You don't want to spend more on interest costs than you would have with your current mortgage.

Renew to a Lower Mortgage Interest Rate

Each mortgage payment contributes to your mortgage principal and interest. A lower mortgage interest rate means more of each payment is directed to paying your principal. If you keep your payments the same while reducing your mortgage interest rate, you can pay off your mortgage faster.

You can usually renew your mortgage without penalties at the end of your term. This is a great time to shop around and compare mortgage rates from different lenders. There are no penalties for changing mortgage lenders at the end of your term. Most lenders offer a promotional rate if you haven't banked with them before. If you mention shopping around, your existing lender may also attempt to match other mortgage rates.

The Bottom Line

While investing in a rental property will earn you a higher ROI than paying off your mortgage, it's not for everyone. Choosing to pay it off will save you in interest costs. There are several ways to do this, including making lump-sum payments, refinancing to a shorter-term or renewing to a lower interest rate. Just be sure to know if your mortgage is open or closed beforehand. This will help you determine the best strategy to pay off your mortgage fast while avoiding fees.

FAQ

You can make large lump-sum payments without incurring penalties if you have an open mortgage. However, if you have a closed mortgage, you will be limited to the options mentioned above or for your term to end. Once your term has ended, you can pay the remaining mortgage off.
Yes, when your mortgage term completes, you have the option to make a lump-sum payment before renewing to another term.
While you can earn a higher return on investment by investing the money into a rental property, it comes with the stress of managing tenants. It comes down to your priority for increasing your income or peace of mind. If you have a chunk of cash sitting in your bank account, you will save money by using it to pay off your mortgage. However, keep an emergency cash balance equivalent to three to six months of income.
Your mortgage amortization is the amount of time you are predicted to pay off your mortgage. The most common amortization in Canada is 25 years.
The best way to calculate this is by looking at your mortgage amortization schedule. This is the roadmap that shows how each mortgage payment contributes to your balance and when it's expected to be fully paid off. You can use an amortization calculator to determine how increasing your payments or making lump-sum contributions will affect how soon you can pay it off.
If you can handle managing an additional property, investing in a second rental property will typically earn you a higher return on investment.
While it is tough to predict how your stocks will perform each month, over the long term, you will earn a higher return on investment by holding stocks instead of paying off your mortgage. This is because stocks, on average, make you a higher return than your mortgage rate costs you.
Yes, it is better to pay off your mortgage instead of holding money in a savings account. This is because the average savings account in Canada returns less than 1% each year. Meanwhile, your mortgage interest rate will likely cost you 3% to 5%.
The calculators and content on this page are provided for general information purposes only. WOWA does not guarantee the accuracy of information shown and is not responsible for any consequences of the use of the calculator.