Definition:
Mortgage prepayment refers to paying off part or all of your mortgage balance before the scheduled term ends. This can involve making extra payments on top of your regular monthly payments or paying off the entire mortgage early. Prepaying your mortgage can help you save on interest costs and reduce the overall length of your loan.

Types of mortgage prepayment

There are several ways to make prepayments on your mortgage:

• Extra payments: This includes making additional lump sum payments towards the principal or paying more than the required monthly amount. This reduces the outstanding balance and interest charges.
• Accelerated payments: With an accelerated payment schedule, you make more frequent payments (e.g., bi-weekly instead of monthly). Over time, this can significantly reduce the length of your mortgage and the amount of interest paid.
• Paying off the full balance: Some homeowners choose to pay off their mortgage entirely before the term ends, either when they have the funds available or after selling their property.

Benefits of mortgage prepayment

Making prepayments on your mortgage can offer several financial benefits:

• Save on interest: Prepaying reduces the principal amount, which means you’ll pay less interest over the life of the loan.
• Shorten the mortgage term: By reducing your mortgage balance, you may be able to pay off your loan faster than originally planned.
• Financial freedom: Paying off your mortgage earlier can provide you with financial peace of mind and more flexibility in your budget.

Prepayment penalties

While prepaying your mortgage can save you money, it’s important to be aware of potential prepayment penalties. These fees can apply if you exceed the prepayment limits set by your lender. For example, many lenders allow you to make extra payments of up to 15% or 20% of your original mortgage amount each year without penalty. However, exceeding these limits or paying off the mortgage in full before the term ends could trigger fees.

When prepayment makes sense

Mortgage prepayment can be a smart financial move, but it may not always be the best option for everyone. Consider prepaying your mortgage if:

• You have a high-interest rate: If your mortgage rate is relatively high, paying down the principal can save you a significant amount on interest over time.
• You have extra savings: If you have surplus savings, making extra payments can help reduce your debt faster, leading to long-term savings.
• You’re nearing the end of the mortgage term: If you’re close to your mortgage maturity, it might make sense to pay off the balance early and avoid additional payments.

Alternatives to mortgage prepayment

Before making extra payments, consider the following alternatives that might also help improve your financial situation:

• Investing the funds: If your mortgage rate is low, you may benefit more from investing any extra savings in higher-yield investments rather than paying down your mortgage.
• Building an emergency fund: If you don’t have a significant emergency fund, it might be better to save your extra funds for unexpected expenses rather than paying off your mortgage early.
• Paying down other high-interest debt: If you have other debts with higher interest rates (e.g., credit cards), it might be wise to focus on paying them off first.

How to make a mortgage prepayment

To make a prepayment on your mortgage, follow these steps:

• Check your mortgage agreement: Review your terms to understand your prepayment privileges and any potential penalties.
• Contact your lender: Speak with your lender to confirm how to make a prepayment, what options are available to you, and whether there are any restrictions or fees.
• Determine the amount: Decide how much you want to pay, whether it’s a lump sum or additional monthly payments.

Getting professional advice

Before making a prepayment, it’s a good idea to consult with a mortgage broker or financial advisor. They can help you determine whether prepaying your mortgage is the best choice given your financial goals and current situation.

Last modified: November 11, 2024