When signing your mortgage commitment letter you will have to choose your payment frequency. If your goal is to re-pay your mortgage as quickly as possible, then you need to understand how different payment options will affect your repayment schedule.
So what are your options?
In general, most lenders will offer the borrower the option to decide which repayment schedule fits best with their lifestyle. The options include monthly, semi-monthly, bi-weekly, accelerated bi-weekly, weekly and accelerated weekly payments. Let’s use some simple math to determine which payment frequency will assist you in paying back your mortgage in the shortest time possible.
For the purposes of this exercise and to keep things simple, let’s use $100,000 as our mortgage amount. We’ll use a 5 year fixed rate at 2.54% with a 25 year amortization period and interest being compounded semi-annually.
As you can see from the table above, choosing to pay your mortgage more frequently doesn’t result in reducing your amortization schedule. The key to reducing your amortization is to make sure you choose an accelerated re-payment schedule.
We are going to focus on Accelerated bi-weekly vs. bi-weekly payments but the same principle can be applied to accelerated weekly payments as well.
Okay, we’ve just determined that accelerating your mortgage payments will reduce your amortization and the interest you pay. How does accelerated bi-weekly vs bi-weekly result in more principle being repaid?
It’s important to think of your payments as a stream of income for the mortgage lender. Mortgage payments are comprised of principal and interest payments. The interest is calculated based on your outstanding principal balance, meaning once the interest has been paid, the remainder of your payment is used towards paying down your principal balance.
By choosing an accelerated repayment schedule, the monthly payment is divided by 2 (bi-weekly) or by 4 (weekly). There are 52 weeks in a calendar year so if you make 26 bi-weekly payments, you are in effect paying your Lender the equivalent of 13 months of payments per year compared to 12 months payments with all non-accelerated repayment schedules.
This accelerated repayment of principal is what shortens your amortization.
13 monthly payments ÷ 26 = accelerated bi-weekly payment
Example: ($449.96 per month x 13 months) ÷ 26 = $224.98 accelerated bi-weekly payment
With a non-accelerated or regular payment plan, the Lender takes 12 months worth of payments and divides this by either 26 or 52 to come up with the bi-weekly (or weekly) payment. With this adjusted payment, the Lender still receives a stream of income of 12 monthly payments per year, so there is no additional principal available to accelerate the amortization.
12 monthly payments ÷ 26 = regular bi-weekly payment
Example: ($449.96 per month x 12 months) ÷ 26 = $207.67 regular bi-weekly payment
So now you know why choosing accelerated bi-weekly vs. bi-weekly payments results in 1 extra month of payments per year, which in turn shortens your amortization.
I always recommend this to anyone who can afford the increase in payment but I understand this option isn’t right for everyone. Another option to help shorten your amortization is to increase your payments, meaning more principal paid.
When you’re choosing your next mortgage, make sure you discuss payment options with your Dominion Lending Centres mortgage professional that align with your overall goals for repaying your mortgage.
Thank you to my DLC colleague Brent Shepheard for this article.