Mortgage Repayment Options

Prepayment options allow borrowers to make lump sum payments or pay off the mortgage in full during its term, while repayment options focus on adjusting the method or structure of mortgage payments.

Periodic Payment Increase

This option allows borrowers to raise their monthly mortgage payments, often by as much as 100% of the original payment amount, during the loan term. This can be a valuable strategy for paying off the mortgage faster and reducing overall interest costs. A significant advantage of this feature is the flexibility it offers: if the borrower can no longer sustain the increased payments, most lenders permit them to reduce their payment amount, provided it doesn’t drop below the original amount.

The timing and size of the payment increase directly influence the amount of money saved. As illustrated in the accompanying chart, even a modest increase—such as 25%—can lead to substantial savings.

While increasing payments later in the mortgage term will also reduce interest and accelerate repayment, the impact will be less pronounced compared to starting earlier in the loan cycle.

Effects of Increasing Mortgage Payments over time

In the mortgage below we used a mortgage amount of $320,000, annual interest rate of 3.89%, semi-monthly payments, and 25 year amortization.

Accelerated Mortgage Payment

An accelerated mortgage payment option enables borrowers to increase their periodic mortgage payments from the outset, even before the first payment is due. Unlike a periodic payment increase, which must be requested after the mortgage has been advanced, this option allows for adjustments right at the start.

Accelerating a mortgage payment has little to do with changing the payment frequency. Contrary to popular belief, the real factor that accelerates a mortgage is increasing the payment amount, not altering the frequency.

To illustrate this, consider Nancy, who takes out a $200,000 mortgage amortized over 25 years at a 6% interest rate compounded semi-annually. Her regular monthly payment is calculated as $1,279.62. Over 300 payments, her total repayment would be:

$1,279.62 × 300 = $383,886

If Nancy opts for weekly payments instead, her weekly payment amount is $294.74. Over 1,300 weekly payments, her total repayment would be:

$294.74 × 1,300 = $383,162

The savings from switching to weekly payments are:

$383,886 (monthly) – $383,162 (weekly) = $724

This $724 savings over 25 years is far from the substantial savings often claimed. The minimal difference arises due to slightly faster principal repayment with weekly payments, but it’s not the significant impact borrowers are often expecting.

To produce meaningful savings we must increase the periodic payment amount. We calculate this by dividing the monthly payment by the number of payments in the new frequency. For example, to determine an accelerated weekly payment:

Monthly Payment ÷ 4 weeks = Accelerated Weekly Payment

By increasing the periodic payment amount, borrowers can substantially reduce the loan term and total interest paid, truly accelerating the mortgage repayment process.

It’s important to understand that a month is not exactly four weeks long, except for February. If a month were only four weeks, there would be just 48 weeks in a year (4 weeks × 12 months). This discrepancy is what creates the effect of an accelerated payment. To calculate the accelerated weekly payment, the monthly payment is divided by 4:

$1,279.62 ÷ 4 = $319.91

This new weekly payment is higher than the non-accelerated weekly payment calculated earlier. By making weekly payments of $319.91, the mortgage would be repaid in 1,092.34 payments, instead of the longer repayment schedule with non-accelerated payments.

The total cost of the mortgage under accelerated weekly payments is:

$319.91 × 1,092.34 = $349,450.49

Comparing this to the total paid with non-accelerated weekly payments:

$383,162 (non-accelerated) – $349,450.49 (accelerated) = $33,711.51

This represents significant savings. The effect of accelerated payments is essentially the equivalent of making one extra monthly payment each year. This applies not only to weekly payments but also to bi-weekly or monthly payments, as long as the payment amount is increased.

In summary, accelerating a mortgage payment involves increasing the payment amount, not simply changing the payment frequency. The key is in making what equates to an additional monthly payment annually, which substantially reduces the mortgage term and overall interest paid.

Lump Sum Payment

A lump sum payment allows borrowers to make a payment directly toward the principal balance of their mortgage. Similar to periodic payment increases, this can lead to significant savings over time by reducing the total interest paid. The impact of a lump sum payment is most pronounced when it is made early in the loan term.

For example, if a borrower makes a $20,000 lump sum payment (10% of the original loan amount), the total repayment amount will include this payment. The following chart demonstrates how applying this lump sum at different points in the mortgage term affects overall savings.

When comparing a one-time lump sum payment to increased regular payments, consistently increasing monthly payments over the life of the mortgage yields the greatest savings, provided the borrower’s cash flow allows for it. If increasing regular payments isn’t feasible, making a lump sum payment as early as possible is the next best option. Combining both strategies—higher regular payments and an early lump sum—can maximize savings and reduce the mortgage term significantly.

Effect of Making a Lump Sum Payment

In the mortgage below we used a mortgage amount of $320,000, annual interest rate of 3.89%, semi-monthly payments, 25 year amortization, and a lump sum payment of 20k.

Extended or Shortened Amortization

Extended Amortization

As property values have grown significantly compared to incomes, lenders have introduced creative solutions to keep mortgage payments manageable. One such solution is extended amortization, which allows borrowers to spread their mortgage payments over a longer period, such as 30 years instead of the traditional 25 years. This reduces the monthly payment, making it easier for borrowers to qualify for a loan or enabling them to borrow a larger amount.

Example: Extending the Amortization
Consider a $320,000 mortgage with a 3.89% interest rate, compounded semi-annually, and semi-monthly payments:

• 25-Year Amortization: semi-monthly payment = $834.45. Total repayment = $169,047.
• 30-Year Amortization: semi-monthly payment = $753.43. Total repayment = $208,012.

By reducing the semi-monthly payment by $81, the borrower pays an additional $38,965 in total interest over the life of the mortgage. While this option helps make homeownership more affordable on the monthly basis, borrowers must be informed about the increased long-term interest costs.

To offset these costs, borrowers can shorten the amortization period later if their financial situation improves, allowing them to pay less interest overall. If your terms don’t allow for this in your current mortgage, you can renegotiate this as your mortgage renewal.

Extended amortization can also enable borrowers to qualify for higher loan amounts. For instance, if a borrower can afford a $1,279.62 payment, a 30-year amortization allows them to borrow $215,126 instead of $200,000, increasing their buying power by $15,126.

This option has contributed to sustaining higher property values by enabling borrowers to qualify for more expensive homes. Similar options have been available internationally, such as in the U.S. and even Japan, where 100-year amortizations were introduced during the peak of their real estate bubble.

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Shortened Amortization

Reducing the amortization period decreases the total number of payments needed to pay off a mortgage. Although it increases the monthly payment, it significantly reduces the total interest paid over the loan’s term, saving the borrower money.

Strategies like accelerated payments or periodic payment increases effectively shorten the amortization period, resulting in faster loan repayment and reduced interest costs. For more details, refer to earlier sections.