When you take a mortgage loan, the default payment option tends to be monthly. For many different reasons, like household budgeting being monthly, many working people getting monthly salaries, etc.
But there are other options, like accelerated payments, that could help you manage your loan better and pay it off faster. Of course, the primary criteria in determining a payment schedule is your own capacity to pay. If you make it too ambitious, you run the risk of default and penalty. If you make it too safe, you will have unutilized cash while you pay interest on loan outstandings to the bank.
What is an Accelerated Mortgage Payment?
An accelerated mortgage payment refers to voluntary payments made by a borrower to pare down the loan outstandings faster than the scheduled plan, bringing down the lifetime interest cost, and building home equity faster.
Many lenders permit accelerated payments within defined limits, say 20% every year. Some contracts could have disincentives built in for accelerated payments. Hence, one needs to understand the type of contract one has. An ideal situation is where the borrower is able to project the future cash flows reasonably accurately and build a contract that fits in snugly with it. If you foresee that you could be in a position to accelerate, ensure that the terms allow it to be done.
As a thumb rule, the higher the rate of interest on the loan, the greater the benefit of prepayment or accelerated payment.
Mortgage Payment and Accelerated Payment Options in Canada
Most lenders in Canada offer the following types of mortgage payment options:
Monthly
This is the default payment schedule offered by lenders and most commonly chosen by borrowers. 12 payments will be made during the year, on the same date every month.
Semi Monthly
Instead of one payment per month, the borrower will make two payments in the month, equally spread out across the month, such as the 1st and 15th, or 2nd and 16th, of every month. The amount of each payment will be half the amount that is determined as the monthly payment. In a full year, you will pay exactly the same as the monthly option.
Bi-Weekly
Payment is made every alternate week. Since there are 52 weeks in a year, the annual payment as per the monthly plan will be divided by 26, half the number of weeks in the year, to arrive at the amount to be paid every alternate week. In a full year, you will pay exactly the same as the monthly option.
Bi-Weekly Accelerated
In this option, the monthly payment will be divided by two, as in the semi-monthly option. However, the amount arrived at will be paid every alternate week.
What does this mean?
The semi-monthly option pays back 24 instalments during the year. With the bi-weekly accelerated option, 26 payments of that same amount will be made. This means that an amount equivalent to two semi-monthly instalments, or one monthly instalment, will have been paid additionally. You will see your home equity building faster.
Weekly
The annual payment is divided by 52 weeks of the year, and that amount is paid every week. You will end up making the same total payment during the year as you would have made in the monthly option.
Weekly Accelerated
In this option, the monthly payment will be divided by four. However, the amount arrived at will be paid every week.
What will this result in?
Dividing by four yields an amount, 48 instalments of which will equate to the monthly payments over a year. However, since the amount is being paid weekly, and the number of weeks in a year are 52, that is the number of instalments that will be paid. Thus, the borrower will end up paying 4 more weekly instalments, equivalent to one additional month, during the year.
Lump Sum
This option, that permits paying back in chunks, is also available in some contracts, though it is not a regular payment mechanism. However, it has a place here because it is an accelerated form of paying off the mortgage loan.
The Financial Forum for borrowers
Mortgages and home financing are important financial decisions. The Financial Forum makes it their job to make the process easy for you. We don’t work for any lender. Our job is to make sure that you ask relevant questions and take an informed decision. Reach us on (905) 265-0246 or mortgages@thefinancialforum.ca.
