Pre-payment privileges help reduce the amount of time it takes to pay off your mortgage. Plain and simple. But how does it work?
Although it can differ between lenders, most lenders offer prepayment privileges and some as high as 20/20. This means you can increase your regular payment by up to 20% and apply lump sum payments of up to 20% of your original mortgage amount each year as well.
An example would be on a $450,000 mortgage amortized over 25 years at a fixed rate of 2.44% where the lender allows for a 20% increase to your regular payments:
If you were to make your regular payments of $2,002.43/mo with no monthly increase, your remaining amortization after 5 years would be 20 years. Makes sense, right?
Now, if you were to make your regular payments with a 20% increase, taking your payments to $2,402.92/mo, your remaining amortization after 5 years would be 14 years and 8 months knocking off over 5 years of amortization!
Lump sum payments can have an even greater impact on your mortgage, even more than increasing your regular payments as each lump sum payment you make is applied directly to the principal of your mortgage.
This results in immediately reducing the amount of interest you pay each month and in turn will reduce your scheduled amortization period. Using the example above you would have the option to put up to $90,000/year in extra payments on your mortgage. If you were to take advantage of this option alone, you could pay your mortgage off in less than 5 years.
Although we all dream of being able to do that, it’s not realistic. This is why most lenders allow you to apply lump sum payments in increments as low as $100 throughout the year as long as you stay within that 20% allowance.
So what’s the moral of the story? With standard mortgage options you have a lot of flexibility to pay your mortgage off much faster than what you may have assumed.
If you would like to find out more, feel free to reach out as we are here to help you make informed decisions to save you time and money!