Paying Off Your Mortgage Faster: Prepayments and Payment Frequency

A little more each month, or a lump sum once a year, can take years off your mortgage and save you tens of thousands of dollars in interest. Here is how prepayment privileges, payment frequency and amortization work in Canada, with worked examples, and what to weigh before you prepay.

The short version

How your payment works

Each payment covers the interest since your last payment, and the rest goes to the balance. Early on, most of it is interest. Take a $600,000 mortgage at a fixed rate of 4.5% with a 25-year amortization. Canadian fixed-rate mortgages are compounded semi-annually, not in advance, so the monthly payment is $3,320.84. In the first month, about $2,229 of that is interest and about $1,092 goes to the balance. If the rate stayed the same for all 25 years, you would pay about $396,000 in interest.

Every extra dollar you pay goes straight to the balance, so it saves the interest that dollar would have cost for the rest of the amortization. Variable-rate mortgages work the same way, though lenders calculate their interest differently, some monthly and some daily.

Prepayment privileges

Most closed mortgages let you prepay without a penalty, up to a limit set in your contract. Not every lender allows it, so check yours. Privileges usually come in two forms:

• A lump sum each year, as a share of the original mortgage amount.
• A higher regular payment. Once you raise it, you normally can't lower it again until the end of the term.

Some examples from the big lenders' own pages:

• RBC: up to 10% of the original principal once in every 12-month period, and "Double-Up" payments of up to the principal and interest part of your regular payment.
• TD: a lump sum of up to 15% of the original principal once a year, and payment increases of up to 100%.
• CIBC: 10% to 20% a year depending on the mortgage, and payment increases of up to 100%.
• Scotiabank: 10%, 15% or 20% a year, depending on the options you choose.
• National Bank: up to 10% of the amount borrowed in each calendar year.

Treat it as a yearly allowance, and check your contract before assuming unused room carries over to the next year. Open mortgages let you prepay as much as you like without a penalty, though some lenders set a small minimum, and they usually have higher rates and shorter terms.

What a prepayment saves

Using the same $600,000 mortgage at 4.5% over 25 years:

• One $10,000 lump sum after the first year: about $18,700 less interest, and the mortgage is paid off eight months sooner.
• $5,000 every year: about $78,000 less interest, paid off in 20 years and 7 months.
• $10,000 every year: about $129,000 less interest, paid off in 17 years and 6 months.
• A payment 10% higher, $3,652.92 instead of $3,320.84: about $68,000 less interest, paid off in 21 years and 3 months.

Even $10,000 a year is under 2% of the original amount, well inside most lenders' limits.

Payment frequency

The Financial Consumer Agency of Canada explains the options this way:

• Semi-monthly: your monthly payment divided by 2, paid twice a month.
• Bi-weekly: your monthly payment times 12, divided by 26.
• Weekly: your monthly payment times 12, divided by 52.
• Accelerated bi-weekly: your monthly payment divided by 2, every two weeks.
• Accelerated weekly: your monthly payment divided by 4, every week.

Because a year has 26 two-week periods, accelerated payments add up to one extra monthly payment a year. On the example, regular bi-weekly payments of $1,532.70 save only about $1,800 over the life of the mortgage. Accelerated bi-weekly payments of $1,660.42 save about $60,100 and pay it off in about 21 years and 8 months. Accelerated weekly payments of $830.21 save a little more, about $60,800.

25 or 30 years

A longer amortization lowers your payment but costs more interest. On the example, a 30-year amortization brings the monthly payment down to $3,025.29, about $296 less, but adds about $92,900 in interest. With less than 20% down, 30 years is available only to first-time buyers and buyers of new builds, and it adds 0.20 percentage points to the insurance premium. With 20% or more down, your lender sets the maximum. A longer amortization gives you a lower required payment, and prepayments still shorten it.

Penalties if you pay too much

If you pay more than your privileges allow, or pay off the mortgage before the term ends, you may owe a prepayment penalty. On a fixed rate, it is usually the greater of three months' interest and the interest rate differential. The Financial Consumer Agency of Canada gives this example: on a $200,000 balance at 6%, with 36 months left and the lender's posted rate for a three-year term now at 4%, three months' interest is about $3,000, but the interest rate differential is about $12,000. On a variable rate, the penalty is often three months' interest.

To keep penalties down, use your privileges every year, and if you plan to pay off a large amount, check the penalty first. It is sometimes cheaper to wait until your term ends.

Renewal: the penalty-free moment

• Pay down a lump sum. At the end of your term, you can pay down any amount without a penalty.
• Watch for the statement. If your mortgage is with a bank or another federally regulated lender, it must send a renewal statement at least 21 days before the term ends. Banks such as RBC and TD let you renew up to 120 days early without a penalty.
• Keep your payment. If your rate goes down at renewal and you keep paying the same amount, the extra goes to the balance.

I explain what to do before your term ends in Renewing Your Mortgage.

Before you prepay

• An emergency fund. The Financial Consumer Agency of Canada suggests 3 to 6 months of expenses. Money you put on the mortgage is hard to get back out.
• Other debt. Paying off higher-interest debt first saves more.
• Your RRSP and TFSA. Compare prepaying with using your contribution room. A financial advisor can help you weigh the options.
• Taxes. Mortgage interest on a home you live in generally isn't tax deductible in Canada, though if you rent out a suite or run a business from home, part of it may be.

Questions buyers often ask me

How much extra can I pay on my mortgage without a penalty?

It depends on your contract. Closed mortgages at the big banks typically allow a yearly lump sum of 10% to 20% of the original amount, and many let you raise your payment. Open mortgages let you prepay as much as you like.

Do accelerated bi-weekly payments make a difference?

Yes. They add up to one extra monthly payment a year. On a $600,000 mortgage at 4.5% over 25 years, they save about $60,000 in interest and pay it off about three years and four months sooner.

What happens if I pay more than my contract allows?

You may owe a prepayment penalty. On a fixed rate, it is usually the greater of three months' interest and the interest rate differential.

When can I make a large payment without a penalty?

At the end of your term, when the mortgage comes up for renewal.

Is mortgage interest tax deductible in Canada?

Generally not on a home you live in. Interest is deductible only when the borrowed money is used to earn income, so if you rent out part of your home, the share for the rented part can be deducted.

Choosing a mortgage? Read Fixed or Variable? and How Much House Can You Afford?, or try my mortgage calculator.

This article is general information, not financial advice. The examples assume a fixed rate of 4.5%, compounded semi-annually, that stays the same for the whole amortization, with payments made on time; they are illustrations, not quotes. Lender privileges are from their websites at the time of writing. For the federal guide, see paying down your mortgage faster.