There are two types of mortgages; open and closed mortgages.
With OPEN mortgages there are no limits as to how fast you can pay down your mortgage; however you do pay a higher interest rate for this privilege. Typically, this type of mortgage is used by real estate investors who know they are only going to hold the property for a short time. Their interest expense is also tax deductible.
CLOSED mortgages are the preferred choice for owner occupied properties and also offer privileges for paying down the mortgage faster with the ultimate benefit of reducing the interest you pay over the life of your mortgage. These programs differ from lender to lender; at the end of the day you would not choose a lender based solely on this.
Payment Privileges offer a Few Different Options:
- Annual or periodic lump sum payments: Payments of up to 15%, 20%, or even 25% of the original principal amount are allowed each year.
- Increase your payment: You may also increase your current payment by up to 15%, 20%, or even 100% each year.
- Double your payments: Some lenders also offer the option of doubling any and all payments.
- Accelerated or rapid payments: With each payment (weekly, bi-weekly, or semi-monthly) you apply a small incremental amount of money directly to the principal. This privilege is designed so that every 12 months you make the equivalent of 13 payments.
An example of how taking advantage of even one of these privileges can save you thousands is easily illustrated with the Accelerated Payment Privilege.On a $280,000 mortgage that is amortized for 35 years at 5.3%, the regular bi-weekly payment would be $671.54. The accelerated bi-weekly payment would be $728.36. This would allow you to pay your mortgage off in 28.4 years. Using a constant interest rate, you would save $73,068 in interest expense.
If you were to make a lump sum payment of 2% each year on that same mortgage and just make regular payments, you would pay off the mortgage in 19.75 years and save $161,451 in interest expense...all for an investment of only $5,600 each year, and you would be mortgage free 15.25 years earlier!