# Paying Down Mortgage



## briant (Jun 23, 2009)

I have a simple question and advise on paying down our mortgage faster. I have a 5 year fixed mortgage at 2.99% with 20/20 prepayment privileges. In the first year, we increased our mortgage payment by 20%.

Would it be beneficial to reduce our mortgage payment back to the original amount and put our extra funds into savings account. Then once a year make a lump sum payment directly against principal from the savings account?


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## Spudd (Oct 11, 2011)

No, your way is actually better because the extra money on your payment is going against principal immediately. If you saved it for a year first, you'd be paying an extra year of interest. 

If you have lots of money, you can also do a lump sum once a year of up to 20% on top of your higher payments.


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## mind_business (Sep 24, 2011)

Only if you're worried you don't have enough of an emergency fund, and need to build it up a bit. Otherwise, any time you defer payments for a loan, you will rack up more interest costs.


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## AltaRed (Jun 8, 2009)

I agree. One would have to get well over 2.99% (to get 2.99% after tax) in a savings account/term deposit/GIC to equal the cost of non-tax deductible interest on a mortgage.


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## fraser (May 15, 2010)

I think that it is good financial discipline to keep increasing your mortgage payments, increasing the frequency of those payments, and making any lump sum payment that you can on the anniversary date (or when the mortgage agreement allows).

If you follow this discipline your mortgage will be paid off in no time, or at the very least your amortization period will be reduced substantially. Every extra dollar you put down has an exponential impact.


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## Chris L (Nov 16, 2011)

Agree with what is said. Try to do it in 7 years! Totally possible.


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## MrMatt (Dec 21, 2011)

It's hard to compete with a guaranteed an after tax return of 3%.

Even Bank stocks yielding almsot 4% are only a bit higher after tax (for many people), and neither the dividend, or principal are guaranteed.

That being said, a few years ago I bought 100 shares of the bank instead of making a lump sum prepayment, I'm pretty happy with the results.


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## houska (Feb 6, 2010)

MrMatt said:


> That being said, a few years ago I bought 100 shares of the bank instead of making a lump sum prepayment, I'm pretty happy with the results.


If you or anyone wants to do this to an appreciable extent, it is worth setting up your mortgage so that you make the prepayment, *then* readvance the amount you want and invest it. If you do this right and keep the paperwork straight, the interest on the readvanced/invested portion becomes tax-deductible going forward. 

This is part of that whole complex mess called the Smith Manoeuvre about which there are dedicated threads. People debate whether this is a good thing to do due to its use of leverage, but if you're doing it anyway, might as well get the tax benefit available.


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## briant (Jun 23, 2009)

Thanks everyone for your feedback. I was under the false impression that the 20% increase in mortgage payment I was making wasn't going directly against the principal amount. After looking through my mortgage payments, I noticed that the amount of interest I was paying was roughly the same amount even if I was paying $500 more with the increased payment.

Thanks again for the suggestions. I'll continue to increase my mortgage payments every year, and then make lump sum payments with any extra funds when possible.


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## NotMe (Jan 10, 2011)

As for the reference to an emergency fund, at least with my mortgage (don't know about most) I have a 'mortgage cash account' that extra payments against my mortgage go into, and I could borrow from at my mortgage rate if I needed to.

So rather than having a $350 mortgage balance with a $50K emergency fund earning 1.4%, I have a $300K mortgage with a cash account balance of $50K. I don't earn interest on the $50K, but I'm paying interest on $300K and not $50K. 

I keep a very small emergency fund ($2000k) because it's easier to move money around online that way rather than the cahs account which I'd have to call about, but that's what we do.


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## sprocket1200 (Aug 21, 2009)

Once you reach the point where the interest is less than half the total payment, you will be amazed how fast the principle owing drops off!


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## nobleea (Oct 11, 2013)

So question/discussion about paying down mortgages.

We always hear that every dollar you prepay on your mortgage is like investing in a X% GIC, where X is the before tax amount required to equal your mortgage rate after tax. Good, but in this time of low mortgage rates, people seem to think this is cheap money and not worth it.

I know that in the US, their mortgage terms and ammortizations line up, so the above is certainly true. But I'm not sure it's entirely correct in Canada, where typical terms are 5yrs, but ammortizations are 25 yrs. Since you could have 4 rate resets during your mortgage paying life, I've always thought that your ROI on a mortgage prepay is not based on your current mortgage rate, but on the blended average of all the ones in the future. After all, a dollar you prepay now is a dollar you don't have to reborrow at a different rate when the term is up. Given that we are at very low mortgage rates for some time now, and at some point during most of our mortgage paying lives, the rates will be higher during some of your rate resets/new terms.

What are your thoughts on this? Is it overly simplistic to say that your ROI on a prepayment is your before tax mortgage rate? At least in Canada, I think it's much higher than that.

We've been increasing our mortgage payments 20% a year and prepaying the principal down by 10-20% every year, which means we'll have our mortgage paid off next September, approx 6 years after we moved in. Our rate is only 2.2% right now (P-0.8). The faster you pay the mortgage off, the more your 'effective' ROI approaches your current mortgage rate.


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## OnlyMyOpinion (Sep 1, 2013)

Awesome. 
It will seem like Christmas next October once that monthly mortgage amount is staying in your bank account!
What to do with all that free cash flow?!


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## Echo (Apr 1, 2011)

nobleea said:


> I've always thought that your ROI on a mortgage prepay is not based on your current mortgage rate, but on the blended average of all the ones in the future.


I agree with this, which is why we're throwing a lot at our mortgage in the first 5 years, even though our rate is super low (also 2.2%). If we continue at this pace then we'll have the mortgage paid off in six years (eight years after we moved in).


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## nobleea (Oct 11, 2013)

OnlyMyOpinion said:


> Awesome.
> It will seem like Christmas next October once that monthly mortgage amount is staying in your bank account!
> What to do with all that free cash flow?!


Definitely. Learning to live with the huge monthly prepayments makes it almost like winning the lottery when it's done.
I require a new(er) car, we have to catch up on all our TFSA contributions, start paying for childcare at some point, and saving up for an infill lot.


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## nobleea (Oct 11, 2013)

I keep track of all the prepayments I make to my mortgage. Day, confirmation numbers over the phone, etc.
Last week, I thought I would check the accuracy vs what BMO says I've done in 2013. The first number they threw out wasn't even close. Easily 40K less. I mentioned that wasn't correct, so she had to go through with a calculator and figure it out by hand. Still wasn't right. Made me realise that, at least with BMO, there is no way for them to tell whether you've made more than the 20% max prepay per year. I make prepays on average twice a month with values of anywhere from $100 to 10,000. I just found it odd that they had absolutely no clue whether I had exceeded my yearly limit. I know it's rare that someone could pay more than 20% per year, but I wonder if they would ever know that you had.


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## Jungle (Feb 17, 2010)

nobleea said:


> I keep track of all the prepayments I make to my mortgage. Day, confirmation numbers over the phone, etc.
> Last week, I thought I would check the accuracy vs what BMO says I've done in 2013. The first number they threw out wasn't even close. Easily 40K less. I mentioned that wasn't correct, so she had to go through with a calculator and figure it out by hand. Still wasn't right. Made me realise that, at least with BMO, there is no way for them to tell whether you've made more than the 20% max prepay per year. I make prepays on average twice a month with values of anywhere from $100 to 10,000. I just found it odd that they had absolutely no clue whether I had exceeded my yearly limit. I know it's rare that someone could pay more than 20% per year, but I wonder if they would ever know that you had.


That is weird, with Scotia, it tells you your maximum allowed and updates it instantly when I apply lump sums from HELOC. I use the HELOC as chequing to apply the payment.


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## My Own Advisor (Sep 24, 2012)

To the original question, definitely better to have extra money going on your mortgage principal immediately. Attack the interest that much faster.


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## Jungle (Feb 17, 2010)

nobleea said:


> I've always thought that your ROI on a mortgage prepay is not based on your current mortgage rate, but on the blended average of all the ones in the future. After all, a dollar you prepay now is a dollar you don't have to reborrow at a different rate when the term is up. Given that we are at very low mortgage rates for some time now, and at some point during most of our mortgage paying lives, the rates will be higher during some of your rate resets/new terms.
> 
> What are your thoughts on this? Is it overly simplistic to say that your ROI on a prepayment is your before tax mortgage rate? At least in Canada, I think it's much higher than that..


Check out this calculator on Canadian Mortgage Trends: 
http://www.canadianmortgagetrends.com/canadian_mortgage_trends/mortgage-stress-tester.html

What I like about the calculator is it also factors in what you would normally pay off now until your time of renewal, then it calculats your payments at a higher mortgage rate. 

For our calculations, if rates go up 2.5%, it would increase our mortgage payment by almost $500 a month! Which is not something I want to see subtracted from our cash flow. So like you, I am now agressively paying down the mortgage to when my renewal comes up, it won't take away as much cash flow. (less mortgage to pay off @ higher rate)


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## My Own Advisor (Sep 24, 2012)

I'm with you Jungle. Our mortgage is by far our biggest anchor. Yes, I could probably make more money if I invested the lump sums I'm using for the mortgage, but I sleep better at night by killing debt. I really hope I can be debt-free in 8 years. Seems so far away but if I don't keep after it, it will stay far away.


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