Paying a mortgage can be daunting, especially if you are on a tight budget.
However, there are ways to pay it off faster without getting penalized.
With the right strategies, you can significantly reduce the time and money spent on your mortgage.
This article will teach you how to pay your mortgage faster without getting penalized by your lender.
What is a Mortgage Prepayment?
Prepaying your mortgage means paying down your loan’s principal faster than scheduled.
You can prepay your mortgage in one of two ways:
- A lump sum payment
- A percentage increase of your regular payment. Say your regular mortgage payment is $1,500. You can ask to increase this payment by 30% to a $1,950
- Change your payment frequency to bi-weekly for 13 monthly payments per year.
Generally, prepayment allows you to pay off your mortgage fast.
Fast paying your mortgage can save you tens of thousands in interest expenses over the life of the loan.
But before you prepay your mortgage, you should make sure it’s the right decision for your financial situation.
Here are a few questions to ask yourself to help you make the right decision;
- How much can I prepay each month without penalty?
- Can I sustain a higher regular payment until the end of my mortgage term?
- What are the risks and rewards of prepping my mortgage?
Not every mortgage lender allows fast payment without some penalty.
Learn More: Mortgage Prepayment: Escape Mortgage Penalties And Charges
Restrictive Mortgage Prepayment Terms
Closed Term Mortgages.
Closed-term mortgages cannot be prepaid, renegotiated or refinanced before the end of the term without getting charged a financial penalty.
This mortgage type has the most restrictive mortgage repayment privileges.
These types of mortgages, if they do, limit how much you can prepay the mortgage between 10% to 20% of the loan balance per year.
Any amount over the restricted percentage will incur a prepayment penalty.
Open Term Mortgages
An open-term mortgage can be prepaid, renegotiated, or refinanced before the end of the term without a prepayment penalty charge.
It is a good choice if you want to pay off your mortgage early.
The price for its flexible prepayment term is a high mortgage rate.
Interest rates for open-term mortgages are higher than for closed-term mortgages.
Learn More: Open vs Closed-Term Mortgages: Which is Right for You?
What is a Mortgage Prepayment Privilege?
Mortgage prepayment privilege is the lender’s right to you (the borrower) to make extra payments toward the mortgage principal at no charge.
As explained above, closed-term mortgages have strict payment terms, limiting your ability to pay down your mortgage fast.
If your mortgage doesn’t have a prepayment privilege, any payment you make to the principal above the regular monthly amount will incur a significant penalty charge.
Why Don’t Lenders Want You to Pay Your Mortgage Faster?
Lenders set prepayment restrictions to protect their profit.
Lenders make profits by earning interest on the unpaid balance of your mortgage.
The extra payment you make will reduce the balance owing on your mortgage, reducing the lender’s interest earnings.
Let’s say your mortgage balance is
A simple calculation to illustrate how prepaying your mortgage will affect the lender’s profit.
$400,000, and your interest rate is 4%: your interest expense will be
$400,000 x 4% = $16,000
If you prepay your mortgage by $5000, that will reduce the balance to $395,000
$395,000 x 4% = $15,800
The lender will lose $200 in profit if you prepay your mortgage by $5,000.
To ensure they make their profit. To protect the profit, lenders charge a penalty to restrict you from prepaying the mortgage.
This penalty can be substantial, especially if you are in a new mortgage contract.
How to Pay Your Mortgage Off Faster Without Getting Penalized
Increasing Your Mortgage Payment Amount
Increasing your regular mortgage payment is one way to pay your mortgage fast without prepayment charges.
Most mortgages will allow you to increase your mortgage payment up to 100% during the loan term.
Your mortgage has the following terms
- 5 years fixed-rate
- An interest rate of 2.5%
- mortgage balance of $400,000
- Payment frequency is monthly
- 25 years amortization
Output:
- The monthly payment is $1,791.87
- The interest expense of the loan for the 5-year term is $46,063.61
Let’s use this example to show how quickly your mortgage will be paid off and the interest expense you can save by increasing your monthly payment.
Increase Your Monthly Payments By $500 to $2,091.81
You can choose to increase your monthly mortgage payment by $500, taking it up to $2,091.81
- Interest expense paid for the 5 years is $44,917.65:
- Interest savings is $1,145.96 over the 5-year period
- The loan will be mortgage-free in 23.58 years, saving you 1.42 years and
- You also save $12,941.09 in interest expenses over these 23.48 years.
Overall, you will be mortgage-free in 1 year and 5 months sooner by increasing your regular mortgage payment by $500.
Increase Your Payment Frequency
Increasing your monthly payment to every two weeks (bi-weekly) can help you pay off your mortgage faster without being penalized.
You will make an extra monthly payment to your mortgage per year if you choose a bi-weekly payment frequency.
The extra payment is applied directly to your loan principal, saving you interest expenses and shortening the amortization period.
The default number of times to pay your mortgage is once per month (monthly).
There are other payment frequencies you can choose from, such as;
- Two times per month (semi-monthly): You are making 24 payments in a year.
- Every two weeks (bi-weekly): You are making 26 payments in a year. This should be your best choice if you want to pay the mortgage faster without incurring a penalty.
- Four times a month (weekly): You are making 52 payments in a year.
Make Yearly Lump-sum Payments
You can take advantage of the annual prepayment privilege of your mortgage to pay down your mortgage faster.
The lump-sum payment is applied directly to your principal, reducing your mortgage balance and, thus, interest expense.
This will save you money over the life of the mortgage. Your payment should not exceed the prepayment privilege attached to your mortgage.
You will be charged a penalty for the amount that exceeds your prepayment privilege.
Make the Lump Sum Payment Before the End of the Mortgage Term
Scenario Two: Making a Lump-sum payment of $40,000 to your mortgage principal
You make a lump sum payment of $40,000 towards your mortgage in month 20 of the mortgage term.
- The mortgage balance at monthly 20 is $380,392.08
- Total interest expense over the 5yrs term: $43,010.08
- You will save $3,0253.53 in interest expense over the 5 years term
Make a Lump Sum Payment at the Mortgage Term End
Consider waiting until the end of your term to prepay, especially if your prepayment penalty will be too large.
A closed-term mortgage automatically becomes Open at the end of the term.
You can then make a lump sum at this time without penalty.
How to Avoid Mortgage Prepayment Charges
There are several ways to avoid prepayment charges and renegotiate or break your mortgage before the end of the term.
Here are a few of the tactics you can implement.
Port Your Mortgage
Porting your mortgage means moving your current mortgage contract, including the outstanding balance, maturity date, rate, and remaining term, from your existing property to your new house.
Mortgage porting can only be done with the same lender of your existing mortgage and when you sell your existing house and buy a new one.
Learn More: Mortgage Porting: Everything You Need To Know
Get Your Mortgage Assumed.
When selling your house, you can have the buyer take over (assumed) your existing mortgage.
Transferring your existing mortgage to the new buyer of your home will release you from the liability of the mortgage contract.
The Mortgage Assumption clause allows you to transfer an existing mortgage, including the balance, rate, terms, and maturity, to the new owner of your house.
The new owner has to qualify for the mortgage to assume it.
Learn More: What Is An Assumable Mortgage: All You Need to Know
Choose an Open-Term Mortgage.
An open mortgage has the most flexible repayment term. It has no prepayment restriction.
You can prepay all or part of an open-term mortgage during the mortgage term without prepayment penalties.
The unrestricted prepayment advantage of open-term mortgages comes at the cost of high mortgage rates.
The mortgage rates of open-term mortgages are higher than comparable closed mortgages.
Conclusion
In conclusion, paying off a mortgage earlier than expected can be a great financial move if done correctly.
If you are considering lowering your monthly payments, create a budget and weigh the pros and cons.
If you decide that paying off your mortgage faster is the best choice, look into ways to pay off the principal without incurring early payment penalties.
In conclusion, accelerating mortgage repayment is a viable and worthwhile goal.
It can be achieved without penalties with thoughtful planning and the right approach.
Shortening your loan term is the most straightforward way to reduce your balance quickly, but there are other cost-effective and creative ways as well.
Consider debt consolidation or refinancing if you are looking for long-term savings on interest.
