Are accelerated mortgage payments right for you?
You get paid bi-weekly, why wouldn’t you set your regular mortgage payment to come out on the same frequency? Simple right! And look at how much faster that mortgage is being paid off. Who wouldn’t want that?
As a former personal banking officer, this was a common conversation with my clients, and almost all of them went this route. But over time I’ve discovered that accelerated mortgage payments aren’t all they’re cracked up to be.
Let’s start with the advantages:
Over a twenty-five-year amortization, bi-weekly mortgage payments result in two extra payments per year (26 total), and result in you paying off your mortgage 3 years early depending on interest rates versus someone who made semi-monthly payments (24 per year).
They line up seamlessly with your pay frequency.
But consider this; how many other bills are due on a bi-weekly basis? Other than a car loan, the answer is essentially zero.
This creates a bill management issue. Two months out of the year you’re going to have a spike in your mortgage cost compared to your other expenses. Sure, you’ll have a spike in income too, but wouldn’t it be great if you could use that extra income for something else like: building up your emergency savings, paying off credit card debt, topping up your child’s RESP or your RRSP, or even taking a much-needed vacation. Keeping your mortgage frequency on a semi-monthly or monthly gives you valuable flexibility that isn’t there when you’re attempting to pay the mortgage off as fast as possible.
In the grand scheme of financial choices is paying down a mortgage quickly the best decision you can make?
The average five-year fixed mortgage rate hovers below 4%. If you have a line of credit or credit card, you’re certainly paying more than that. Instead of paying off cheap debt, use that extra paycheck to pay off the more expensive debt. When your credit card is paid off, that’s one less bill stressing you out each month.
Even if you’re debt free, that extra payment could be put into a balanced portfolio inside of a TFSA growing at an average annual rate of 6%. Let’s say your mortgage is $500,000. The accelerated bi-weekly payment would be $1320 twice a year. At the end of 25 years assuming the investments average a 2% better return than the mortgage interest rate, you would have a TFSA with a balance of almost $85,000, and $18,552 wealthier than if you’d paid down your mortgage more quickly to save on interest. To put that into context, $18,000 is roughly how much a Canadian earns annually if they receive the maximum CPP and Old Age Security payments. And having an investment portfolio you can sell in minutes if an emergency strikes or a job is lost gives you a great deal of protection compared to equity buried inside your home.
Before you decide on the frequency of your mortgage payments, keep these ideas in mind so you can make the best choice for your family. And if you’re feeling overwhelmed trying to make sense of your mortgage payments alongside everything else, drop me a line to speak about how I can help you make sense of any financial fuzziness.