# Maximizing my mortgage pre-payment privileges



## seancooper (Jul 1, 2012)

I just purchased a house and was approved for a 5 year closed fixed rate mortgage with First National at 3.04%. First National offers a number of prepayment options.



> First National offers a number of prepayment options including:
> 
> 15% Lump Sum Payment
> You can pay up to 15% of your original mortgage balance each year on any of your regular payment dates. There is a minimum prepayment amount of $100.
> ...


I want to pay off my mortgage the most efficiently possible by paying the least amount of interest. The prepayment options are very generous. Instead of taking a shorter amortization period and not using the prepayment options to their fullest (15 years instead of 25 years), I was thinking of taking a longer amortization period (25 years) and maxing out my prepayment options. See below examples (please note I've used monthly payments for simplicity sake - I plan to pay accelerated weekly).



> Assumptions: I have $2,424.04 per month to contribute to my mortgage.
> 
> Scenario 1
> Mortgage Amount $255,000
> ...


As you can see, even though I'm paying the same amount a month ($2,424.04), I pay less interest in Scenario 1 since $1,212.02 goes directly to principal, instead of only $712.02 in Scenario 2.

You're also allowed to pay up to 15% of your original mortgage balance each year on any of your regular payment dates. That means I could pay $38,250 per year (15% of $255,000) or $3,187.50 per month in prepayment, which goes 100% to principal (is that correct?). So could I save even more by going with a 30 year amortization, paying $1,077.97 per month and doubling up and using the lump sum prepayment to pay the same $2,424.04 per month? Instead I would be paying $1,346.07 per month directly towards principal.

Please confirm if this makes sense. Please note I've used the following mortgage calculator to come up with the numbers.
http://www.geoffparkin.com/default.aspx?PageID=1011


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## Jungle (Feb 17, 2010)

Sounds like it's the same with Scotia. To answer your question, you want to go the shortest amortization possible-not 30 year. Then you can still double up, add 15% per year, etc. All that extra money goes to principal.


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## seancooper (Jul 1, 2012)

Yes, but if I go with the shortest amortization my monthly payments will be higher and I will not be able to afford to "double up" and do 15% lump sum payment directly to principal. Thus, I will be paying more money towards the principal and interest portion (the higher monthly payment), while only using part of my prepayment privileges. Does this make any sense to you? Read my example above to see what I mean.


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## Spudd (Oct 11, 2011)

The advantage of the longer amortization is it gives you flexibility not to pay more if something happens.


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## FrugalTrader (Oct 13, 2008)

Spudd said:


> The advantage of the longer amortization is it gives you flexibility not to pay more if something happens.


+1 for this suggestion. As this is your first house, I'd go with the longer amortization and pay down what you can. After the 5 year term is up, you'll get a better idea of your cash flow and the amount of extra cash you can put on the mortgage. At that point, you can decide to reduce the amortization or change mortgage products (open etc).


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## themortgageguy (Jun 28, 2012)

There is a lot of confusion about the effects that payment frequency has on a mortgage.

Under the same 15 year amortization scenario the difference in interest expense between accelerated weekly vs. accelerated bi-weekly payment is negligible. Just keep that in mind should bi-weekly payments work better for your household budgeting cycle. Payment frequency is not what accelerates a mortgage with any significance, *increasing the payments towards the mortgage does*.

The majority of interest savings in a straight 15 vs. 25 year amortization scenario is because you are paying more against the principle with the shorter am. That’s great if you can do it. The only problem with that is that “life happens” and if for some reason at some point you can’t make the higher payment demanded by the 15 year am then what? I am not often an advocate of shortened amortization periods because life does happen and the flexibility of a lower mandatory payment with a longer amortization offers the flexibility you may need. With generous periodic payments you can still really hammer down the amortization.

You may also be caught up in the whole double-up option. What you’re really doing there is making a periodic prepayment. Even if lenders don’t offer the double up option explicitly most have the flexibility to allow for a double up through scheduled additional payments at the frequency that the double up would have been anyway. Those payments would really just be counted towards your maximum yearly lump sum payment.

I think the real question here is this: Are you comfortable being locked into a mortgage contract at 15 years amortization with the associated mortgage payment being higher?

Look for a lender out there with higher yearly lump sum payment amounts and there are better rates available to boot. The higher the lump sum payment allowances the better because sometimes when life happens, it not always bad. Occasionally people have unexpected money land in their lap and the lump sum payments can be used at anytime during a year before they expire. Once you miss a double up option its gone.

Get the mortgage broker that you are using to confirm the calculations you are asking for. He knows your situation best


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## OhGreatGuru (May 24, 2009)

I think there is a flaw in your analysis. You are looking at "interest saved" between two separate pairs of mortgage scenarios, rather than comparing "total interest paid" between the 15yr and 25 yr. The total interest paid until the mortgage is paid off is close to the same in both cases, ~$41K . (The 15-yr mortgage has total interest of $62,439 if you make no accelerated payments; while the 25-year mortgage has total interest of $108,904 if you make no accelerated payments.) The effect of accelerating payments on the longer term mortgage is greater. Doubling the payments on the 25 yr. mortgage is "saving" you ~$67K out of ~$109K, leaving you paying ~$42K interest. Increasing the payments on the 15yr. mortgage by $712/mo. is "saving" you ~$21K, but leaving you paying ~$41K interest.


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## SW20 MR2 (Dec 18, 2010)

+1 to OhGreatGuru's comments...

Given that you have a specific amount to spend, go with the longer amortization to provide yourself a little buffer in case you need to re-deploy the money for other things in the future (e.g. job loss, marriage, kids, etc).


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## jamesbe (May 8, 2010)

Agreed, I actually took 30 years on my last place JUST because the rates were low (2%) and it gave me the warm fuzzies. I pay more than I have to but know that I can fall back if needed. And heck at the low rates I'm using that money elsewhere, where I can get better than 2% on my money.


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## cardhu (May 26, 2009)

seancooper said:


> I pay less interest in Scenario 1


No, you don’t ... you pay exactly the same amount of interest in both cases ... not just close to the same, but exactly the same ... you are correct that any “prepayments” apply entirely to principal, but you are neglecting the fact that a portion of your “regular” mortgage payment also goes toward principal, such that the combined amount applied to principal is exactly (again, not merely close to, but exactly) the same in both of the scenarios you’ve described. 

You’re starting with the same amount borrowed in both cases, you’re applying the same interest rate, and making the same total payment, on the same schedule ... so how could the interest amounts be anything but identical? 

The only difference between the two scenarios is in the intangibles ... flexibility and potential ... a longer amortization has greater flexibility because you can revert to a lower cash flow if need be, by temporarily suspending your prepayments during a time when, as TMG put it, “life happens” ... the shorter amortization allows you the greater potential for rapid repayment, because any “double-up” type prepayments are based on a larger basic payment amount ... but the reality is that such potential may have very little value, if you’re not able to put it to good use ... if you can’t afford to throw $3500/month at the mortgage, then having prepayment privileges that allow you to do so are not really helping. 

I would suggest that you lean toward a longer amortization, and then go ahead and immediately set up accelerated payments, at whatever level you’re comfortable with. The interest you pay will be the same either way, but as a first-time homebuyer, the flexibility may prove to be more beneficial to you than the potential.


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## VJ99 (Apr 24, 2012)

Hi Sean, 
For any given mortgage with a specified interest rate, the time taken to pay down the mortgage is determined mainly by one thing: how much you pay each month. 
The amortization period - whether its 25 or 15 - is only used to calculate the required minimum monthly amount. 
What you choose to pay above the minimum is up to you. If you pay into a 25 at the same rate as you pay into the 15, then the time taken to paydown the mortgage and the total interest paid will be the same. 
How frequently you pay - weekly, bi-weekly, monthly - doesn't make a material difference for the typical mortgage. If your mortgage was in the millions, different story. 
On this, I agree with TheMortgageGuy. Choose the frequency that matches your cash flow. 
Also, choose the longer amortization and then make higher payments. That gives you flexibility when your cash flow gets squeezed.

To see all this for yourself, here's a spreadsheet. 

http://www.archeretf.com/wp-content/uploads/2012/07/Mortman.xls

I'd suggest opening it on two screens and then entering your two scenarios side by side to really see that there is not a material difference. 
Certainly not enough to spend this much time worrying about it. 

One thing worth giving some thought to is *interest rates*. 
3% interest rates are not going to last. *You will almost certainly have a higher rate* when its time to renew in five years.
To maintain your 15 year plan, you would need to bump up your monthly payments. 
To minimize your pain, the best thing would be to pay as much of the mortgage off in the early years when it is bigger.
In the mortgage spreadsheet, you can input different rates for each period. 
I'd suggest going to the start of year 6 and entering in a rate assumption, say 5%, and seeing what happens. 

Good luck. 
Vikash


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## Mall Guy (Sep 14, 2011)

archerETF said:


> To see all this for yourself, here's a spreadsheet.
> 
> http://www.archeretf.com/wp-content/uploads/2012/07/Mortman.xls
> 
> ...


. . . couldn't open it but believe this gives credence to "enough said" . . . there are plenty of mortgage calculators online that running amortization schedules for various scenarios so that shouldn't be a problem . . . start with a 25 yr am, bump 10 to 15% each year, add a couple of double ups, and a lump sum as you can afford it . . .TRM will want to add that you shouldn't forget about an emergency fund (life happens fund), and maybe a little investing . . . not that hard to do better than 3%


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## Cal (Jun 17, 2009)

I have always wondered about people using the 30 amortization period in case life happens.

If they are that concerned about having to replace a furnace or something....maybe they should not have bought so much house.

Sorry to take your thread in another direction. It is just what came to mind while reading your thread, I know it doesn't help your particular situation.


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## Eclectic12 (Oct 20, 2010)

archerETF said:


> ... For any given mortgage with a specified interest rate, the time taken to pay down the mortgage is determined mainly by one thing: how much you pay each month....
> 
> What you choose to pay above the minimum is up to you.
> 
> If you pay into a 25 at the same rate as you pay into the 15, then the time taken to paydown the mortgage and the total interest paid will be the same....


You must be getting different mortgages than I have. 

Every mortgage I've been offered has had a maximum limit on extra payments (annual, payments or double up). For some of the more restrictive mortgages from years past, bumping up the mortgage payments decreased the annual pre-payment privilege by the matching amount so that if one payed the maximum payment - there was no annual lump sum left.

So not only is it the interest rate, payment amount, frequency and amortization but it is also what the pre-payments allowed will be. Bottom line is the terms of the mortgage are critical as YMMV.


Then too - except for in later years after my income had increased, I found adding to the existing payments far easier to use than a lump sum at a particular time of year. Everyone is different so IMO, considering what one is likely to be able to use is an important aspect.


Cheers


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## jamesbe (May 8, 2010)

^ Well BMO offers the 20/20/20 mortgage which allows you to pay down 20% (extra) of the ORIGINAL value of the mortgage each year. So in theory you could pay your 25 year mortgage in 5 years... or even less I suppose.


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## OhGreatGuru (May 24, 2009)

FrugalTrader said:


> +1 for this suggestion. As this is your first house, I'd go with the longer amortization and pay down what you can. After the 5 year term is up, you'll get a better idea of your cash flow and the amount of extra cash you can put on the mortgage. At that point, you can decide to reduce the amortization or change mortgage products (open etc).



I disagree. You should always get the shortest amortization you can comfortably afford. in OP's budget for the 15yr mortgage he still has $712/mo in discretionary prepayments that can be redirected to other needs if necessary.


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## Shayne (Apr 3, 2009)

OhGreatGuru said:


> I disagree. You should always get the shortest amortization you can comfortably afford. in OP's budget for the 15yr mortgage he still has $712/mo in discretionary prepayments that can be redirected to other needs if necessary.


Why lock yourself into higher payments and limit your control of your cash flow? For example if can afford to pay $2,000 a month with a shorter amortization, but I take a longer one and only pay $1,000 a month. Every month I make a lump sum payment of $1,000 for the same result as the shorter amortization.

If life throws me a curve ball I can just stop making prepayments.


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## cardhu (May 26, 2009)

toolbox said:


> You should always get the shortest amortization you can comfortably afford.


I'm not sure an "always" is required in this situation, but if it were, it surely wouldn’t be that ... the shorter amortization produces exactly the same financial results, but carries more risk ... why should one “always” take on more risk, if there’s no elevated reward associated with it. 




Cal said:


> I have always wondered about people using the 30 amortization period in case life happens ... If they are that concerned about having to replace a furnace or something....maybe they should not have bought so much house.


Having to replace a furnace is hardly a “life happens” event ... and someone who is on pace to pay off a mortgage in 10 years can hardly be said to have taken on “too much house” ... initiating a mortgage at a longer amortization, in the circumstances OP described, is simply a sound risk management practice ... a shorter amortization would not reduce interest expense, and would not result in paying off the mortgage any sooner ... the only advantage it offers is that it slightly (very slightly) boosts the prepayment limits ... but since the vast majority of first-time homebuyers could never, in their wildest dreams, fully utilize the prepayment opportunities already available to them, boosting those limits for that majority would seem to offer nothing of value. On the other hand, the ability to adjust cash flow, during a _real_ life happens event, does offer value ... think of it as insurance ... and like most other forms of insurance, one hopes one never has to actually use it ... but unlike most other forms of insurance, this one is free. 



Eclectic12 said:


> You must be getting different mortgages than I have ... Every mortgage I've been offered has had a maximum limit on extra payments


Methinks you misunderstood ... I don’t believe archer meant that all mortgages are open mortgages ... obviously, prepayment privileges have limits ... it seemed to me that archer’s point (and I’m sure he’ll correct me if I’m wrong) was that how fast a mortgage gets paid off is not determined by the amortization, nor by the limits of the prepayment privileges ... rather, it is determined by the payments you make ... the amortization and the prepayment options merely establish the range within which your payments must fall ... and even then, the upper limit of that range is usually somewhat hypothetical, since the REAL limit on how much a homeowner can pay toward a mortgage is how much money they actually have ... prepayment privileges that allow one to pay as much as $5k per month do little good for someone who’s only earning $50k/yr. 



jamesbe said:


> ^ Well BMO offers the 20/20/20 mortgage which allows you to pay down 20% (extra) of the ORIGINAL value of the mortgage each year. So in theory you could pay your 25 year mortgage in 5 years... or even less I suppose.


You have an extra “20” in there, BMO’s product is only 20/20 ... assuming an initial 25 year amortization, such a 20/20 mortgage could theoretically be paid off, in full, without incurring any penalties, in a mere 36 months ... coincidentally, a 15/15 mortgage with double-up (such as OP described) could also be paid off in 36 months ... very few homebuyers, I suspect, have the ability to make full use of such privileges ... I know I didn’t during the first 3 yrs of my homeownership.


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