When the Bank of Canada increased its key interest rate to 0.75 per cent in July, the key takeaway for many Canadians is that mortgages are about to get more expensive. We’ve been living in an era of ultra-low interest rates for years, and now, for the first time in a long time, mortgages and all other debt are going to cost a little more to service.
This bump in interest rates won’t immediately affect the 66 per cent of homeowners with fixed-rate mortgages, but once those mortgages come up for renewal, they’ll become more expensive. In anticipation of this coming expense, many Canadians have been running the numbers through an online mortgage calculator and are considering paying off their mortgages early.
Early mortgage payoff is already a popular plan, as a recent study by Mortgage Professionals Canada revealed. According to the study, recent home buyers plan to pay off their mortgages in 19.2 years instead of the typical 25-year amortization schedule.
But before you dive into becoming mortgage-free ahead of schedule, there are several factors to consider.
- Are there other debts you should prioritize first?
First, while paying off your mortgage ahead of schedule is an honourable endeavor, if you have higher interest debts, you should tackle those first. If you have credit card debt, a car loan, or a home equity line of credit, you should focus on paying off those before your mortgage because they will most likely have higher interest rates.
- Can you part with the cash?
Once you pay off your high-interest debts, you have a few options to pay off your mortgage early. The most important consideration when paying off your mortgage early is that you don’t drain your cash resources or strain your cash flow. Either of those issues would make you vulnerable to emergencies or job loss, and in those situations, a low mortgage balance won’t be very helpful. There are several ways to pay off your mortgage quicker, and you should choose the one that best balances paying off your debt and your other financial priorities.
If you’d like to dabble in early mortgage payoff without committing significant financial resources, a great place to start is increasing your mortgage payment frequency. Your payment frequency is how often you make a mortgage payment. Most home buyers are familiar with monthly, bi-weekly, and weekly mortgage payments, but you can also make accelerated bi-weekly or accelerated weekly payments. These types of payments use a different calculation to determine the amount you make, resulting in a slightly higher payment that will pay down your mortgage faster. You can use a mortgage payment calculator to determine how switching to accelerated payments will affect your mortgage payment and amortization period.
If you’re very comfortable with your financial situation and have a large chunk of cash you’d like to put towards your mortgage, you can also take advantage of your lump-sum prepayment options. Most mortgages give you the option to prepay a lump sum (usually no more than 10 per cent of the remaining balance) once a year. Remember you should only do this if the lump-sum payment won’t negatively impact your finances.
Finally, if you have plenty of room in your budget, you can shorten your amortization period. A shorter amortization period will increase your monthly payments because you’re paying your loan off over a shorter period. If you go this route, you should make sure your budget can withstand those higher payments, even if something unexpected comes up (losing your job, for example). If you aren’t sure whether you can handle higher payments and a decreased income, you should consider making mortgage prepayments instead.
- Can you earn more money by investing it elsewhere?
While the Bank of Canada’s rate increase has many Canadians considering what higher interest rates will do to their finances, it’s important to remember that the increase was a small one and that mortgage rates are still near historic lows. If you’re comfortable with your mortgage payments, have plenty of wiggle room in your budget and have good cash reserves, paying off your mortgage ahead of schedule might not be the smartest use of your money. Instead, investing the money in a balanced portfolio with an average yield of 5 per cent may be a better use of your hard-earned cash.
- The bottom line
Whether or not you should pay down your mortgage early depends on your situation. If you’re concerned about being able to afford your mortgage when interest rates rise, paying down your mortgage now while rates are still low may be a good strategy. On the other hand, if you’re comfortable with your mortgage payments and you have a very low mortgage rate, putting your money in higher yielding investments might be a better choice.