The dream of home ownership is exciting, but in reality, diving into the real estate market can be daunting. The average cost of a home in Canada reached $519,521 in February, according to the Canadian Real Estate Association.
Even with a substantial down payment, taking on mortgage debt in the hundreds of thousands of dollars isn’t a decision that should be made lightly. It’s worthwhile to explore the options that can help to keep mortgage costs to a minimum. If you’re thinking about buying a home, here are four ways to reduce the cost.
1. Shop around for a low mortgage rate
When looking to keep mortgage costs down, the first place to start is to find the best mortgage rate. Low rates help to minimize regular payments and reduce interest paid over the life of the mortgage.
To illustrate the impact of a lower interest rate, let’s compare a rate of 2.94% against a lower rate of 2.39%, both across a five-year fixed term.
Let’s assume you purchase a $500,000 property with a 20% down payment of $100,000. That would result in a $400,000 mortgage. We’ll also assume you have a 25-year repayment schedule, or amortization, and you make monthly mortgage payments. Over a five-year term, the cost differences between an interest rate of 2.94% and 2.39% are shown in the following table.
| Mortgage rate | Total paid over five years | Principal paid over five years | Interest paid over five years | Balance after five years |
|---|---|---|---|---|
| 2.39% | $106,202 | $62,201 | $44,000 | $337,799 |
| 2.94% | $112,841 | $58,497 | $54,345 | $341,503 |
The lower rate of 2.39% reduces the amount you have to pay by $6,639 over five years. You’ll also put $3,704 more towards your principal and pay $10,345 less in interest. Taking the time to shop around for the best mortgage rate can save you thousands of dollars in the long run.
2. Shorten your amortization period
Another option to reduce the overall mortgage cost is to trim down the amortization period. Long amortization periods result in lower regular mortgage payments but also accrue more interest over time. Shortening the amortization period has the opposite effect. Higher regular payments direct more to the principal balance owed and reduce the interest paid altogether.
Referring back to the example above and a mortgage rate of 2.39%, the costs associated with a lower amortization look something like this:
| Amortization period | Total paid over five years | Principal paid over five years | Interest paid over five years | Balance after five years |
|---|---|---|---|---|
| 20 years | $125,757 | $82,945 | $42,812 | $317,055 |
| 25 years | $106,202 | $62,201 | $44,000 | $337,799 |
Shortening the amount of time it takes to repay the mortgage to 20 years would cost roughly $326 more every month and reduce your principal by $20,744 in the first five years. Assuming a fixed rate of 2.39% throughout the entire mortgage for comparison’s sake, reducing the amortization to 20 years would save you $27,979 in interest.
3. Make accelerated payments
Mortgage payments can be made monthly, biweekly, accelerated biweekly, weekly, or accelerated weekly. With accelerated payments, you pay a little bit more each year. Essentially, you’re making a payment equal to one extra monthly payment a year.
Assuming you have a $400,000 mortgage, an interest rate of 2.39%, and a five-year term, with a biweekly payment schedule, you’ll pay $817 every other week. If you choose an accelerated biweekly payment schedule, your payments will be $885 every two weeks.
| Payment frequency | Total paid over five years | Principal paid over five years | Interest paid over five years | Balance after five years |
|---|---|---|---|---|
| Biweekly | $106,145 | $62,201 | $43,944 | $337,799 |
| Accelerated biweekly | $115,052 | $71,654 | $43,397 | $328,346 |
Looking back at our example above, choosing an accelerated biweekly payment schedule will mean slightly higher regular payments. Although the amount of interest you pay is slightly lower, you’ll put more towards your principal and pay off your mortgage more quickly.
4. Make extra payments
One final way to reduce mortgage costs is to make extra payments. Lump-sum payments are applied directly to the principal balance. In practice, a $10,000 lump-sum payment would save $2,390 in interest at an interest rate of 2.39%.
Be sure to check the terms and conditions of your mortgage agreement as the rules for extra payments can vary by lender. For instance, some lenders impose prepayment penalties.
The bottom line
Whether it’s finding the best interest rate, reducing the amortization, opting for accelerated payments, or making extra contributions, calculating the costs and potential savings doesn’t need to be complicated. Use a mortgage payment calculator to see how changing the variables can affect how much interest you pay and how long it takes to pay off your loan.
Finding the right balance can help to turn your dream into a reality, save you tens of thousands of dollars, and leave you mortgage free sooner.
RateHub.ca is a website that compares mortgage rates, credit cards, high-interest savings accounts, chequing accounts, and insurance with the goal to empower Canadians to search smarter and save money.
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