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When you buy a house with a 25-year mortgage, it can feel like a life sentence. You’re committing to a quarter-century of payments that you must make without fail, or risk losing your home. So, what if there was a way you could pay down your mortgage faster — a “get-out-of-jail-sooner” card, so to speak — that you could use to shorten the amount of time that you’re locked-in to making those payments?
Well, there is. And not just one way; there are several strategies you can use to pay off your mortgage faster — including the one I used to shave nearly 10 years off mine. Read on to find out what I did, as well as other methods for paying off your mortgage early.
Why Pay Off Your Mortgage Faster?
Before getting to the nitty-gritty of how to pay down your mortgage more quickly, let’s examine the reasons why it could be something worthwhile to do:
- To save money on interest. The less time you take to pay off your mortgage, the less interest you pay. You can save literally tens or hundreds of thousands of dollars in interest over the lifetime of your mortgage by paying it off faster. Why pay more if you don’t have to?
- To earn a guaranteed rate of return. If you are choosing between paying off your mortgage early or investing, the return you get for paying down your mortgage is clear: it’s the money you save on interest. It’s possible you might earn a better rate of return by investing those savings instead, but in order to do that, you’ll likely have to take on some risk — meaning your earnings are not guaranteed. You’ll almost certainly get a better rate of return by paying off your mortgage than you would by leaving those savings in a typical bank account.
- To gain financial freedom. Once you pay off your mortgage, you’ll have a significant monthly expense wiped from your budget. You can then use that money any way you like — to save more in other long-term investments (such as retirement or an RESP) or short-term priorities, like travel.
Strategies to Pay Off the Mortgage Faster
When you set up a mortgage, your lender will tell you how much your monthly payment will be. A percentage of that payment will go toward reducing the sum you’ve borrowed — or the mortgage principal — while the rest is interest or the fee you pay the lender to borrow the money.
The key to paying down your mortgage early is by making regular additional payments, which go directly toward reducing the mortgage principal. That is the name of the game, after all. Once you’ve reduced the principal to zero, you’re done.
There are a number of ways to make these regular additional payments, as described below.
#1. Get a Lower Interest Rate — But Keep Your Payments The Same As Before
When you’re shopping around for the best mortgage lender or renewing an existing one, you obviously want to get the best rate you can. This will reduce the amount of interest you will pay over the life of the mortgage. But note that this strategy alone will not help you pay off your mortgage sooner — unless you also set your payments at the higher rate.
To show how this works, let’s look at an example.
Say you were considering a five-year closed fixed mortgage with a large national bank at a rate of 5%. Your monthly payment at 5% interest would be $1,744.81, and you’d pay $223,444.49 in interest over the life of the mortgage (assuming your rate stays at 5% for the entire 25 years, which is unlikely but helps illustrate the concept). However, let's say you were approved for a better rate at 2.94% with an online mortgage lender. Your monthly payment at 2.94% would be $1,410.52 and you would save a bundle in interest — more than $100,000 — over the 25-year amortization.
But now assume that you set your payment according to what it would be at the higher rate ($1,744.81) even though your lender is only charging you 2.94% interest. In effect, that 2.06% difference in interest is going directly toward paying off your principal every month. Your amortization would decrease to 18.6 years, and you’d pay a total of only $89,169.79 in interest, or a savings of $134,274.70.
|Calculation summary for $300,000 mortgage (25-year term) |
|5% Interest||2.94% Interest||2.94% Interest|
|Number of payments (amortization)||300 (25 years)||300 (25 years)||223 (18.6 years)|
As you may have guessed, this is the strategy I used to shave 10 years off my own mortgage. When I bought my home in 2005, the two rates I was looking at were a five-year fixed rate and a much lower variable rate from the same lender. I decided to go with the variable rate but set my payments as if I went for the fixed rate. It was a kind of built-in hedge: if rates went down (as they did) I was laughing; if they went up, I’d have already paid down a good chunk of the principal. I reduced my amortization even further by choosing an accelerated bi-weekly payment schedule, which is explained in more detail below.
By the way, shopping around for the best mortgage lender is key to making this a successful strategy. For a credit union, Meridian currently offers a 5-year closed fixed mortgage at 2.59%, and 5-year closed variable mortgage at 2.90% — some of the lowest rates in Canada. For one of the best online bank, motusbank has mortgage interest rates as low as 2.49%. Do your homework and find the best mortgage interest rate to suit your circumstances.
#2. Make Mortgage Pre-Payments
Depending on the rules of the mortgage you choose, you can pay extra amounts that go directly toward reducing your principal either as a lump-sum once or twice a year, on a recurring basis, with every payment, or whenever you want. Some mortgages, such as a closed mortgage, may limit the additional amount you can pay each year to 15% of the total mortgage — but that’s still a significant amount that can go a long way toward reducing your amortization. A mortgage calculator can help you see how much time and interest you’d save by adding pre-payments.
For example, as we see in the table below, a $300,000 mortgage paid monthly at a 4% rate of interest and a 25-year amortization would cost $173,418.18 in interest over the 25 years of the mortgage. But if you pay just $100 more every month in a pre-payment, which goes directly toward reducing the principal, you’d have finished paying off the mortgage two-and-a-half years sooner and save nearly $20,000 in interest. If you could manage an extra $200 more every month, you’d be done paying the mortgage after 20 years and eight months (instead of 25 years) and you’d save $34,000 in interest.
|Calculation summary for $300,000 mortgage (4% interest rate; 25-year term)|
|Monthly payment (12x year)||Monthly payment (12x year)||Monthly payment (12x year)|
|Number of payments (amortization)||300 (25 years)||271|
|Mortgage payment amount||$1,578.06||$1,578.06||$1,578.06|
|Total payment amount||$1,578.06||$1,678.06||$1,768.06|
#3. Increase Your Payment Frequency
While the standard interval to pay a mortgage is once a month (or 12 times per year), you can also choose to pay semi-monthly (twice a month, or 24 times per year), bi-weekly (every two weeks, or 26 times a year) or weekly (52 times per year). Because mortgage interest accumulates daily, the greater the frequency, the less interest you will pay, and the faster you’ll pay off your mortgage.
You could also choose an accelerated bi-weekly schedule, which is essentially the amount of a monthly mortgage divided by two, and you pay that amount every two weeks. By doing this, you end up paying a “13th-month” mortgage payment, which goes entirely toward reducing the mortgage principal. This strategy alone would shave more than three years off your mortgage and save nearly $25,000 in interest compared to the basic monthly mortgage above with no prepayments ($173,418.18 – $148,871.90 = $24,546.28).
If you really want to get a bang for your buck, try combining an increase in payment frequency along with a regular pre-payment amount. As you see in the chart below, you could shave nearly seven years off a $300,000 mortgage (at 4% interest) by adding an extra $100 to each accelerated bi-weekly payment, or pay off the mortgage nearly 10 years sooner if you added an extra $200 to each payment. In the latter case, you’d have also saved a whopping $70,000 in interest compared to the basic monthly mortgage with no prepayments ($173,418.18 – $102,974.01 = $70,444.17).
|Calculation summary for $300,000 mortgage (4% interest rate; 25-year term)|
|Accelerated bi-weekly (26x year)||Accelerated bi-weekly (26x year)||Accelerated bi-weekly (26x year)|
|Number of payments (amortization)||569 (21.9 years)||475 (18.25 years)||407.5 (15.67 years) |
|Mortgage payment amount||$789.03||$789.03||$789.03|
|Total payment amount||$1,578.06||$889.03||$989.03|
The Bottom Line
There are good reasons to pay off your mortgage early, not the least of which is the peace of mind it brings. If you want to be debt-free sooner, consider the strategies we’ve outlined and see what might work for you. You’ve got nothing to lose — except your mortgage.
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