Interest rates have been (and still are) at historical lows, many consumers are taking advantage of low payments to purchase the homes they love.  When I ask most people how they are using this low rate environment to their advantage, there is usually a short (or long) pause while they try to figure out what that means.  

Let’s make a comparison:

How much faster will you pay off a $350,000 mortgage amortized over 25 years at 3.50% versus 2.50%? 3 years, 5 Years, 10 Years?

  • The answer may surprise you, you won’t.  They will both take 25 years!
  • To clarify, you will pay a lot less interest, $174,218.73 (3.50%) versus $119,548.30 (2.50%), so, $54,548.43 less over that time, but, you will have the same debt for the same amount of time

How is this possible?

Head Scratch

Here’s what happens:

  • In the above example the monthly payment at 3.50% is $1,747.45, while the monthly payment at 2.50% is $1,565.19, a difference of $182.26, not too much really.
  • Most people just take the 25 year amortization because that is what they are offered without any advice as to how to reduce this .

Banks earn money when you owe them money. Is it realistic to assume the ‘Specialist’ employed by the bank will recommend you pay them off faster?

It’s two opposing forces, the bank wants you to owe them money for as long as possible and you want to pay them off as soon as possible.

How to beat the bank:

Plan Ahead

Using the numbers above, what if:

  1. You take an interest rate at 2.50% (remember the 25 year payment is $1,565.19), but, you make payments as if your interest rate was 3.50% ($1,747.45) adding $182 to your payment. Your amortization is reduced immediately to 21.5 years. That’s 3.5 years sooner!
  2. Let’s take that a step further, what if you can afford to pay an extra $300 per month? Your amortization becomes 17.5 years. That’s 7.5 years sooner! 7.5 years is a long time, what could you do with 7.5 years of mortgage payments in your bank account? That is $184,270.50 ($2,047.50 per month x 12 months x 7.5 years) that you don’t have to put towards your mortgage.

money stack

What people seems to forget is that everything extra you pay goes to the principal of your mortgage, that is your equity in your house.  As a bonus, mortgage interest is generally calculated semi-annually (twice a year), not in advance, so, the faster you pay down the mortgage, the less interest you pay the bank.

A lot of people have the  good intention of paying down their mortgage faster, they say to themselves, yes, I have the extra money in my budget, but, I will pay extra in a few months. The sad truth is that only around 17% of Canadians even pay any extra money at all towards their mortgage.

Think of paying down your mortgage as paying yourself, many people have regular RRSP contributions, insurance payments and they don’t even miss the money.  It is usually directly withdrawn from their account, guess what, so is your mortgage.

The amount of money isn’t the important thing, you don’t need to put tens of thousands extra towards your mortgage every year, most people don’t have that much extra money.  What is important is that every extra dollar you put towards your mortgage principal is your money!

You have to create a realistic strategy that fits your budget and goals.  Working with an experienced, independent Mortgage Broker will provide you with the best of all worlds when planning a strategy: the best rates, the most flexible prepayment privileges and most importantly, unbiased advice.

If your not happy and you don’t go with my recommendation, I don’t get paid.  Can the salaried employee at the bank say that?

Morgan Vaughan is a licensed mortgage broker with over 14 years experience in the mortgage industry.  Providing excellent service, expert advice.

Contact Morgan or call at 416-481-2903 to discuss your situation or get a second opinion.