Should you pay off your mortgage quickly or add to your savings?
Buying a home is one of the biggest purchases of our lives. And since the total amount of interest paid over the life of a mortgage can be considerable, it may be tempting to pay off your mortgage faster to pay less interest.
Why pay off your mortgage faster?
In some cases—like if you have extra cash and you've already contributed the maximum to your registered plans—you may want to prioritize paying off your mortgage. This strategy has a number of benefits:
- You could save a lot of money in the long run. Every dollar that you pay towards the principal will reduce your mortgage balance—and this lowers the amount used to calculate interest over the life of your loan.
- You could become "mortgage-free" sooner. For many people, mortgage payments are the biggest expense in their budget. Paying off your loan a few years early will give you more financial freedom.
- You could increase the equity in your property. Equity is the portion of your property that belongs to you, either because it has increased in value or because you've paid off that portion—or both! If you need financing for other things down the road, you can use your equity as leverage to get better loan conditions.
In some cases, it might be better to maximize your registered retirement savings plan (RRSP), tax-free savings account (TFSA) or registered education savings plan (RESP) contributions instead of paying off your mortgage sooner. If you've already maxed out your contributions to these plans, you might want to make accelerated mortgage payments. Obviously, if you're carrying high-interest debt, like credit card debt, you should pay that off first.
Generally speaking, no more than 40% of your gross household income should go to covering your financial commitments and debt payments, including your mortgage payment and other housing expenses, like property taxes, school taxes and energy costs.
How can you pay off your mortgage faster?
Here are some strategies to pay off your mortgage faster, using either regular payments or a lump-sum payment. Generally speaking, this money will be applied directly to your mortgage balance, which will reduce interest moving forward.
1. Increase the frequency of your mortgage payments: By doing this, you'll spread your annual interest expense over a larger number of payments, which could help you pay down the principal faster.
2. Increase your payment amount: Once every calendar year, you can increase the amount of your regular payments with no fees or penalties, up to twice the amount set out in your original contract. Important: The total increase over the term can't be more than twice the payment amount set out in your contract.
3. Make prepayments: Have you received a tax refund or a bonus at work? You could use this money to make a lump-sum prepayment (maximum of 15% of the original mortgage amount per calendar year).
It's important to carefully plan your mortgage repayment strategy.
Make sure you keep room in your budget for unexpected expenses. You should feel confident about the mortgage you choose and your budget in general.