# Increasing mortgage payments vs. Making lump sum payments



## FinancialUnderdog (Mar 30, 2015)

I just refinanced our property, and was given a new payment schedule. Last time we got our mortgage, we increased our payments by roughly 5% every year as our income grew. This time, I'm thinking of doing it differently by sticking to the original payment amount and banking the extra payments and making lump sum contributions (allowed up to 20%/year, same with payments) - and in the mean time may be investing it.

The question is - does one method has any financial advantage over the other? I think it comes down to how soon the extra payments affect the interest the company is collecting from us. For example, if the extra payments going toward principal saves us money on interest effective next payment, then it makes sense to increase the payments. But if they recalculate the interest payments every year instead - then it only makes sense to give them the lump sum once a year.

Can somebody explain this to me like I'm a 7 year old baby, and not a 34 year old grown man who doesn't know how mortgages work?


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## heyjude (May 16, 2009)

A payment against the principal immediately lowers the principal remaining by the amount you put in. The amortization period drops at once. Increased payments will be divided into principal and interest, so the benefit will be much more incremental. 

Scotiabank has a calculator that lets you model this. 

My preferred way of slaying the mortgage is by paying down principal.


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## FinancialUnderdog (Mar 30, 2015)

Heyjude,

I found the calculator you mentioned (http://cgi.scotiabank.com/mortgage/mffc/en/Scotiabank-LTSB-English.html), and it's quite fantastic. I've played around with both scenarios, thank you for sharing it.

How do you pay down your principal? Do you do a lump sum payment once on a regular basis?


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## heyjude (May 16, 2009)

FinancialUnderdog said:


> How do you pay down your principal? Do you do a lump sum payment once on a regular basis?


No, I just pay down a lump sum when I have cash to spare and the returns make sense. I'm retired, so that's sporadic. For example, when I sold my principal residence a few years ago I had a lot of cash looking for a home, so I paid off a HELOC and put the maximum annual prepayment on my mortgages (I have rental properties). This year I used part of a tax refund. I have a 5 year GIC at 3.5% maturing in the fall in my TFSA, and the best possible safe return I can get for that money is to pay down some of a mortgage at 4.2%. I pay down the debt with the highest interest rate, unless it's small enough to pay off completely, because eliminating a mortgage payment is an immediate boost to cash flow. And so on. I have eliminated 80% of my debt over the past 4 years just taking advantage of such opportunities. 

I really like Scotiabank's calculator. I'm glad you find it useful.


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## Emjay85 (Nov 9, 2014)

I'm under the impression that any payment over and above your set payments are applied directly to your principal.


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## heyjude (May 16, 2009)

Emjay85 said:


> I'm under the impression that any payment over and above your set payments are applied directly to your principal.


That's true, but (for example) if you increase your monthly payments by $100, your principal will drop by that amount each month and it will take a full year before you have shaved $1200 off the principal. If you were to put a year's worth of increased payments ($1200) against the principal now, your principal immediately drops by $1200. Less interest to pay in the long run.


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## rsyl (Aug 15, 2014)

FinancialUnderdog said:


> This time, I'm thinking of doing it differently by sticking to the original payment amount and banking the extra payments and making lump sum contributions (allowed up to 20%/year, same with payments) - and in the mean time may be investing it.


Personally in your situation I would just pay the mortgage as soon as I have the cash (assuming your bank allows it, and it's not risk to needing the money). The sooner you pay the mortgage down the sooner you save on interest.

Whether you pay $1200 vs the principle now versus $100 per month works out like this.

$100,000 starting point @4% interest

Ending balance end of year one

No extra Payments 97,611.70
Monthly $100 extra Payment 96,389.64 (save 22.05) (or 1.8% of the $1200)
Lump sum payment of $1200 (on last day of month one) 96,367.35 (Save 44.35) (or 3.6% of the $1200)

You say you will maybe invest the difference until the payment comes through, in my experience people don't do what they plan to do so the money could sit in your account collecting next to nothing. If you will legitimately invest those funds you could potentially come out ahead depending how the investments do.


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## Butters (Apr 20, 2012)

exactly, the sooner you put money down on the house, the more you save in interest

weekly or biweekly options are the best, if you can double them up, even better


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## My Own Advisor (Sep 24, 2012)

FWIW,

We pay our mortgage via accelerated bi-weekly payments and put extra payments on the mortgage on that same schedule. This is good for our budgeting purposes I find; fixed amount to mortgage AND fixed prepayments as well.


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## Vicjai (May 15, 2015)

Financial Underdog, think about it in a common sense kind of way. I would keep paying your regular payments but make extra LUMPSUM contributions whenever you can. Make sure you are also within your allowable amounts on a closed mtg. 
I prefer lumpsum payments since every dollar you put in goes directly towards paying down the principle amount on the amortization instantly, whereas the addition to your regular monthly payments means you're getting rid of your loan slower vs lumpsum. In otherwords, given same amount of payment of lumpsum vs monthly, paying lumpsum is fastest way to become mtg free, saving you money on interest in the long run. each:


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## 0xCC (Jan 5, 2012)

FinancialUnderdog said:


> [...] This time, I'm thinking of doing it differently by sticking to the original payment amount and banking the extra payments and making lump sum contributions (allowed up to 20%/year, same with payments) - and in the mean time may be investing it.
> [...]





heyjude said:


> That's true, but (for example) if you increase your monthly payments by $100, your principal will drop by that amount each month and it will take a full year before you have shaved $1200 off the principal. If you were to put a year's worth of increased payments ($1200) against the principal now, your principal immediately drops by $1200. Less interest to pay in the long run.


It seems like in this case FinancialUnderdog is considering doing the inverse of what heyjude is suggesting. Starting with $0 extra cash today and saving up some extra every month and then after some number of months applying a lump sum to the mortgage. In that case it only makes sense to save and invest the extra payments if you can achieve an after-tax and after fees/commission return that is greater than the interest being paid on the mortgage. Given today's mortgage rates that might be possible but it isn't guaranteed.


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## heyjude (May 16, 2009)

0xCC said:


> It seems like in this case FinancialUnderdog is considering doing the inverse of what heyjude is suggesting. Starting with $0 extra cash today and saving up some extra every month and then after some number of months applying a lump sum to the mortgage. In that case it only makes sense to save and invest the extra payments if you can achieve an after-tax and after fees/commission return that is greater than the interest being paid on the mortgage. Given today's mortgage rates that might be possible but it isn't guaranteed.


Here's an example. I have a maturing 5 year GIC at 3.75% (those were the days!). Looking around for somewhere to invest the proceeds. Don't need more equities. But I have a mortgage at 4.2%. So that's where it's going. Guaranteed 4.2% return. What's not to like? 

18 months from now that (smaller) mortgage will be up for renewal. Let's say I can get 2.3% on a new term. Lump sum payments would be less attractive at that point.


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