Mortgage prepayment refers to paying more than the regular mortgage payments you have agreed to pay in your mortgage contract.
Examples of prepayment:
- increasing the amount of your regular mortgage payments
- making lump-sum payments to reduce your mortgage balance
- paying off your mortgage in part or in full before your term is over.
If your mortgage gives you prepayment privileges, you can save thousands of dollars in interest charges by paying down your mortgage faster.
However, if you have a closed mortgage, your lender will generally require you to pay a charge to make a prepayment that is more than your privileges allow.
Prepayment charges can be costly, so it is important to know when they can apply and how they are calculated. Prepayment charges are sometimes called penalties or breakage costs.
If you have an open mortgage, you can prepay any amount without paying a prepayment charge.
When you shop around for a mortgage, look carefully at the prepayment privileges and charges as you consider your options
What are prepayment privileges?
Prepayment privileges are terms of your mortgage contract that allow you to pay an amount toward a closed mortgage on top of your regular payments, without triggering a prepayment charge.
For example, each year, your privileges might allow you to:
- make a lump-sum payment up to 15 percent of the original mortgage amount, and
- increase your regular payments by up to 15 percent.
Privileges vary from lender to lender. Generally, if you do not use a privilege, you cannot carry it over to the next year.
Farah received a raise which allowed her to save $20,000. She wants to use it to make a prepayment on her mortgage at the beginning of the second year.
- Mortgage amount: $200,000, amortized over 25 years
- Prepayment privileges: lump-sum payment of up to 10% of original mortgage amount allowed once a year
- Assumptions: for this example, the interest rate will be 5.45% for the entire 25-year mortgage. (In reality, interest rates are only valid for the length of a fixed-rate term and will likely change.)
By using her privileges, Farah can make a lump-sum payment of $20,000. This prepayment will reduce the amount of interest Farah will pay over the life of the mortgage by more than $44,000. She will be able to pay off her mortgage over four years sooner.
You can use our Mortgage Calculator at www.skyfinancial.ca to find out how much you can save by making prepayments.