By Nick Holloway - 

When borrowers are finalizing their mortgage options, they need to decide how they want to schedule the regular payments. There are many options to choose from, while my general recommendation leans toward choosing a repayment schedule which fits best with the households budgeting needs and requirements.

You can select your regular mortgage payment amounts on a monthly, semi-monthly, bi-weekly, or weekly basis. Alternatively, you can opt to pay down your mortgage loan “principal” balance quicker by using an accelerated bi-weekly or accelerated weekly repayment schedule. To understand the repayment schedule, we must initially understand the parameters of the repayment period, which is referred to as the amortization schedule, commonly set to 25 years in Canada. Each regular payment is broken out into a “principal” and “interest” component, noting the amortization schedule reduces the overall principal balance owed over time. As a result, the balance of the payment amount applied to principal balance increases and likewise decreases the interest component over time. In other words, you only pay interest on the remaining principal balance at the time of making your payment, basing the necessary interest calculation on this principal balance and period elapsed from the preceding regular payment being received by the lender.

What repayment frequency should I choose?

We can break this out into two main categories, a regular repayment, or an accelerated repayment schedule. The regular repayment schedule will amortize the loan to match the amortization period, which we will set herein at 25 years for the sake of consistency. Noting that you are only paying interest on the balance of the principal at each regular payment interval, the increase in frequency from say a monthly to bi-weekly payment doesn’t have a significant bearing on the overall interest costs over the lifetime of the mortgage. To make a quick comparison, we can annualize the projected payment amount by multiplying the monthly payment by 12, the bi-weekly by 26 and the weekly by 52, then comparing the sum of those differences. For example, if we take an initial $500,000 mortgage principal balance with a 2.5% contract interest rate compounded semi-annually, the regular monthly “principal and interest” payment comes to $2,239.83. The annualized payment total is $26,877.97, with the bi-weekly totalling $26,862.99 ($14.98 less than monthly), followed by the weekly totalling $26,856.57 ($21.40 less than monthly).

What is an accelerated repayment schedule?

The accelerated repayment schedule is calculated by simply taking the regular monthly payment amount, then dividing this amount in two for the accelerated bi-weekly or dividing in four with the accelerated weekly schedule. Essentially, this results in increasing the overall amount of your payment contributions over time as the borrower is making the dollar equivalent of 13 monthly payments over the span of a 12 month period. If we carry over from the above example and annualize this amount, we have $26,877.97 + $2,239.83 = $29,117.80. The effect of this increase in your overall payment contributions results in an “acceleration” of the principal balance being paid down over time, which reduces the timeframe of a 25 year amortization to around 22 years and 5 months to extinguish the principal balance in this example. If we hold these same parameters constant, the projected interest costs over the lifetime of the mortgage are $171,949.34 for the regular monthly payment, which is reduced to $152,296.60 with the accelerated bi-weekly option. The benefit is an overall interest saving of $19,652.74 over the lifetime of the mortgage loan, however this benefit is moderated by an increase in the regular payment amount which has the effect of reducing the households overall cashflow.  

Are there other ways to pay down the principal quicker?

Mortgages in Canada come with a variety of pre-payment privileges which allow the increase of your regular payment amount and/or applying lump sum payments which similarly have the effect of paying the mortgage principal down quicker than the amortization schedule selected. Arguably, these pre-payment privileges can be tailored to more exact specifics of the borrower’s overall goal and budgeting requirements in respect of increasing the pace of principal paydown, while still managing the cashflow needs of the household. These strategies are however not mutually exclusive since the pre-payment privileges can be combined with the accelerated repayment schedule to suit the borrower’s requirements accordingly. As with many things in life, one size doesn’t fit all.