Hello all, and Happy New Year! Now that the holidays are behind us, we turn our attention forward. Over the past few days, many of us have set and begun executing our new year’s resolutions. Some of our goals are financial, some fitness related, and others are more general, but all have one thing in common – they’re aimed at personal improvement.
January is a great time of year to improve your financial affairs. It’s also when many of our clients ask us how they can pay off their largest source of debt (their mortgage) more quickly. Here are four ways you can accelerate the payment of your mortgage:
1) Make more frequent payments. When setting up a mortgage, there are several options you can choose from in terms of payment frequency. Such include monthly, semi-monthly, bi-weekly, weekly, etc. Choosing the most frequent payment option available to you can drastically alter the duration of your mortgage.
For example, if the amortization of your mortgage is 25 years, making mortgage payments on a weekly basis (which approximate the equivalent level of monthly payments) will reduce your pay-off period by almost three years. In other words, simply choosing weekly payments over monthly payments would land you debt free three years sooner. Seems like a no-brainer to me.
2) Take advantage of your annual payment window by putting windfall money towards your mortgage. As you are likely aware, there are penalties associated with excess or early mortgage payments. There are a few reasons for this, but most notably, financial institutions like to maintain a level of certainty and predictability over their loans. That being said, most mortgages do offer their clients the opportunity to put lump sums towards their mortgage on an annual basis.
If and when you receive notable amounts of cash (e.g., a bonus or inheritance), it would be wise to set that money aside and pay down your mortgage – within allowable limits, of course. Paying off debt is like investing in a risk-free asset, earning (by saving) you money at your prescribed mortgage rate.
3) When your mortgage is up for renewal, shop around. Most people get comfortable, even complacent, with their financial institution. I suppose there’s something to be said for rhythm and routine when it comes to your mortgage. That said, it is one of the biggest expenses you’ll ever have, and as such, it is always prudent to see what’s out there every chance you get.
Often, financial institutions will at least match prevailing rates that are out there, but what most people don’t realize is that it is up to them to show prevailing rates to their banks – and negotiate! Just one-tenth of a percent difference in interest rates, on say, a $350,000 mortgage, amounts to thousands of dollars in saved interest over the life of a mortgage.
4) Shorten your amortization period. This suggestion is pointed a little more towards renewals and/or new mortgages. Asking your bank for a shortened amortization period, say 15 years instead of 25, is one of the simplest ways to force yourself into paying down your loan early. Yes, shortened amortization periods will result in higher payments, but it does wonders in saving the total interest you’ll pay across the life of a mortgage.
I’ll leave you with one final thought. Above, I mentioned how paying off debt is like investing in a risk-free asset, and that your rate of return in doing so equals the interest rate that you were paying. That being said, there’s more to the story. Your rate of return can actually be higher than the interest rate attached to the debt. This becomes apparent when considering income tax.
Because the interest on a mortgage is not typically tax-deductible, the rate of return you would have to obtain on an alternative investment would have to be higher than the interest rate on your mortgage to truly match the return associated with paying down the debt. This is because income tax would come off the investment income you would earn.
For example, let’s say you earn a 5% rate of return on an investment, and your marginal tax rate is 40%. This would leave you with a 3% after-tax rate of return [40% X 5% = 2% and 5% – 2% = 3%]. As such, if the interest rate on your mortgage is higher than 3%, you’d be better off paying down the debt than investing your money at 5%.
In short, pay off your mortgage debt as quickly as possible. It’s a certain way to achieve financial freedom.
Personable and professional, Brent Soucie specializes in cross-border tax and financial planning for U.S. citizens and/or Green Card holders residing in Canada, as well as Canadian residents with U.S. employment and/or property. His clients include professional athletes, entrepreneurs, and corporate executives.
These articles are for general informational purposes only. Please obtain professional advice before taking any action based on this information. No endorsement or approval of any third parties or their advice, information, products or services should be implied by any references to third parties contained in any article. Trademarks cited in these articles are the respective properties of their owners.