Reducing the borrowing costs of your mortgage
Canada Life - Mar 25, 2022
What would a lower mortgage mean to you and your family?
As housing in Canada keeps getting costlier, there are ways you can save on your mortgage to maximize every dollar you make.
There are two ways to reduce the overall borrowing costs on your mortgage:
- Reduce the amount borrowed (principal)
- Lower interest costs
Reducing principal when buying a home:
The less you borrow, the less interest you’ll pay overall. A larger down-payment will decrease the original amount you have to borrow, lowering the amount of interest you’ll pay. The minimum down payment you need to pay on your mortgage is 5% of the principal amount. A down-payment of 20% or more eliminates mortgage insurance costs, bringing down your overall cost of borrowing.
If the down payment is less than 20%, lenders require borrowers to purchase mortgage insurance. These mortgages are known as ‘high ratio.’ The fees for mortgage insurance can be as much as 4.5% of the mortgage value. On $350,000, that means $15,750.
Reducing the principal once you own a home:
As a homeowner, you can usually take advantage of pre-payment options or payment frequency options that allow you to make extra payments on the principal amount.
Adjust your payment frequency:
Assumptions:
- Mortgage: $350,000
- Amortization: 25 years
- Interest rate: 3.0%
| Frquency | Payment | Time to pay down | Total interest costs | Total paid for mortgage | Saving vs. monthly payments |
|---|---|---|---|---|---|
| Monthly | $1,656 | 25 years | $146,908 | $496,907 | - |
| Accelerated bi-weekly | $828 | 22 years, 4 months | $128,309 | $478,309 | $18,598 |
| Weekly costs | $414 | 22 years, 4 months | $128,115 | $478,115 | $18,792 |
By moving to an accelerated biweekly payment (vs. current monthly payments), you can make extra payments towards your principal each year, which leads to savings over time. In this example, the client saves $18,598 and can reduce their amortization by almost 3 years.
Take advantage of pre-payment
A pre-payment arrangement in a mortgage contract allows you to make principal-only payments.
The amount of pre-payment allowed can vary from 5-20%, depending on your lender. It can be based on your original mortgage balance or the mortgage balance you have at the beginning of each year. It can also be made in different ways, such as one-time annual payments or double-up payments.
How does this translate into savings?
Let’s take the same example above. This time, the mortgage holder applies a $5,000 pre-payment to their mortgage each year from an employment bonus they receive.
- Mortgage: $350,000
- Amortization: 25 years
- Interest rate: 3.0%
| Frequency | Time to pay down | Total interest costs | Total paid for mortgage |
|---|---|---|---|
| Monthly scheduled | 25 years | $146,908 | $496,907 |
| With annual pre-payments | 18 years, 3 months | $102,664 | $452,664 |
Here, the homeowner saves $44,243 and is able to reduce their mortgage amortization by 6 years and 9 months.
Interest rates
A lot of people focus only on the interest rate when it comes to their mortgage. Let’s look at an example to see if the impact of the lowest rate is that significant.
We’ll use the same numbers as the previous examples, but with a 0.10% lower rate.
- Mortgage: $350,000
- Amortization: 25 years
- Interest rate: 2.90%
| Interest rate | Payments | Total interest costs | Total paid for mortgage |
|---|---|---|---|
| 3% rate | $1,656 | $146,908 | $496,907 |
| 2.90% rate | $1,638 | $141,537 | $491,536 |
A 0.10% lower rate over the length of the mortgage could help save $5,371. These savings are certainly nothing to throw away. A great rate definitely has an impact, but it’s more important to have a mortgage with the features and flexibility you need to match your unique financial goals.
Contact me to learn more.