Taking out a mortgage is the largest financial commitment that most people will ever make. The length of the mortgage can be intimidating, and keeping up the payments can often be a struggle. However, there are ways to save on a mortgage by considering various strategies which may initially cost a little more money, but can result in quite significant long term savings.
When a homeowner makes a mortgage payment, the lending institution pays the interest on the loan first, and then applies the remaining balance to pay down the principal amount of the loan. Most new mortgage holders do not realize how much of their monthly mortgage payment consists of interest, and how little actually goes to the principal.
An analysis of a $300,000 mortgage on the Canadian Imperial Bank of Commerce mortgage payment calculator demonstrates the true cost of a mortgage quite dramatically. With an interest rate of 5.14 percent, the monthly payment on a five-year term mortgage amortized over 25 years is $1,769. When the borrowers renegotiate the mortgage at end of the five-year term they will find they have paid $35,687 on the principal and $74,510 in interest, leaving an unpaid balance of $274,117.
But significant savings can be realized by paying down the principal and thus reducing the amount of interest that will be charged.
Increase the payment
A relatively small increase in the monthly mortgage payment can result in significant savings over the life of the mortgage. For example, according to the CIBC mortgage calculator for our example of a 25-year mortgage, the addition of a mere $50 per month to the mortgage payment will save a borrower $22,851 in interest payments and reduce the time required to pay off the loan by two years.
Pay more frequently
Spreading the monthly payment out over the month and scheduling bi-weekly or weekly payments will painlessly increase the annual number of payments from 12 to the equivalent of 13, and thus result in the payment of an additional $1,769 over the course of the year.
Make lump sum payments
Lump sum payments will be applied directly to the principal. Some mortgages offer a “double up” option which allows the mortgage holder to make extra payments during the year. The mortgage may also allow an annual lump sum payment. Using the CIBC website again, the effect of a one-time prepayment of $1,000 on a $300,000 mortgage will save the homeowner $2,534 in interest over the life of the loan. If that $1,000 is paid annually, the total interest savings will amount to an impressive $25,854.
Renegotiate the mortgage
The end of a mortgage term is an excellent opportunity to explore further opportunities to save on interest. It is usually possible to make a lump sum payment before renewing the mortgage for a second term, and even a small payment to the principal can result in dramatic savings.
Shortening the length of the term is another way to save. For example, our sample mortgage was based on a five-year term amortized over 25 years. At the end of the five year term, there will be 20 years left on the mortgage. The best course of action is to choose the shortest affordable amortization schedule. A small reduction in the amortization period from 20 years to 18 years, for example, will save two years of payments without increasing the monthly payments unduly.
When interest rates are low, the principal can be paid off faster. Therefore, when renewing a mortgage at a lower interest rate, while it may be tempting to reduce the monthly payments, it is actually smarter to increase the amount going to the principal by maintaining the same payment schedule.
These strategies will help homeowners put money in their own pockets instead of the bank’s coffers, and allow them to own their home outright in a much shorter period than the original length of the mortgage. Homeowners who are mortgage free have few financial worries, more discretionary income and funds available for renovations, both for their own comfort and pleasure and to increase the home’s resale value.