Why it’s a good time to pay off your mortgageDec 20, 2016
Canadian household debt has just reached a new record high of 166.9 per cent of disposable income, meaning that the average Canadian owes $1.67 for every dollar they earn. Canadians now have over two trillion dollars in debt, with mortgage debt making up the vast majority of it, at $1.31-trillion. And, even though the Bank of Canada (BoC) maintained its 0.5 per cent interest rate at its last meeting, a recent rate increase in the U.S. could lead to higher mortgage rates in Canada. If you’re currently carrying mortgage debt, this might be a good time to review your mortgage terms with your lender so you can pay off your mortgage debt sooner.
Mortgage rates are already rising
Last month, Royal Bank of Canada raised the rates on its fixed-rate mortgages by 25 to 40 basis points (0.25 to 0.4 per cent), a couple of weeks after Toronto Dominion Bank (TD) raised its prime mortgage rate for the first time in 15 months. Although TD’s rate increase was smaller—just 0.15 per cent—it was more notable in that it affected variable-rate mortgages, which normally only go up when the BoC raises rates. While 15 basis points isn’t much of an increase, the fact that they raised while the BoC held pat could be somewhat concerning for consumers—especially if other banks decide to follow suit.
Why mortgage rates (typically) rise in Canada
Although TD and Royal Bank both raised rates last month, they did so on different products. Royal Bank’s rate increases applied to its fixed-rate mortgages, while TD’s move only affected its line of variable-rate mortgages. Do you know which kind of mortgage you have?
A fixed-rate mortgage has one set interest rate for its full duration. This means that, even if you had a fixed-rate mortgage with RBC, you would not have to worry about your mortgage rate increasing—except if it’s coming up for renewal. Fixed-rate mortgages are typically based on the bond market, so when bonds start to rise, fixed mortgage rates will also go up. In some cases, bond yields can rise even when the BoC’s interest rate doesn’t—for instance, an interest-rate increase in the U.S. is likely to increase bond yields in other countries, including Canada.
A variable-rate mortgage can vary throughout the life of the loan, based on the overnight lending rate set by the Bank of Canada. That’s what makes TD’s rate increase so unusual—they raised their prime rate while the BoC’s remained flat. A variable-rate mortgage will often start off with a lower interest rate than a fixed-rate one, but you’d be taking a risk that your rate might go up during the life of the mortgage, and you would then have to adjust your payments accordingly.
How to pay off your mortgage faster
If you’d like to get ahead of an interest-rate increase and start paying off your mortgage debt sooner, the Financial Consumer Agency of Canada (FCAC) has four different ways you can do so:
1.Increase the amount you pay each month: This comes with a couple of caveats. First, you will need to check with your mortgage lender to see if they’re willing to renegotiate your payment terms. And if so, you would need to make the same increased payment for the duration of your mortgage; you won’t be able to pay a bit more for a month or two, then go back to your previous payment.
2.Renew at a lower rate, but make the same payment. Although mortgage rates seem to be more likely to increase than decrease in the near future, they have actually fallen quite a bit over the past 10 years. This is good news if you have a 10-year mortgage coming up for renewal. Since you’ve already set aside a certain amount for mortgage payments, you can keep making that same payment at your new, lower rate in order to pay off your mortgage sooner.
3.Accelerate your mortgage payments. If you pay off your mortgage under an accelerated payment schedule, you will end up making 13 months’ worth of payments each year. Instead of a weekly or bi-weekly payment plan, you would choose a monthly mortgage payment, and pay an equal portion of that amount every week or every two weeks, dividing your monthly payment by four or by two. This method could potentially save you thousands in interest—check out this chart on the FCAC site.
4.Make lump-sum prepayments. This one should almost be considered optional—some mortgage lenders do not allow prepayments, and those that do might charge you fees or penalties for doing so. You will want to check with your lender before considering any lump sum payments, but if you’re able to make these prepayments without penalty, it could likely be the best way to pay off your mortgage sooner.
Should you pay off mortgage debt sooner?
For most Canadian homeowners, a mortgage is their single largest form of debt. And if you’re nearing retirement, are anticipating a smaller income in the near future or would simply like to get ahead of an interest-rate increase that would stretch your budget, it might make sense to pay off your mortgage sooner. But if you’re carrying multiple forms of debt, such as car loans, payday loans and/or credit cards, you’ll probably want to pay those off first. Right now, most lenders are offering mortgage rates between two and three per cent, while you could be paying up to 20 per cent annual interest on a credit card, and as much as 600 per cent on a payday loan. Paying off these forms of debt first could end up costing you less interest than your mortgage.