BC Sunshine Coast real estate by Menno at Royal lePage Real estate on the BC Sunshine Coast

The average Canadian mortgage is currently about $151,000. This includes all mortgages, even those that were just taken out on a new loan as well as those that are almost paid off after years and years of steady payments.

A big mortgage is currently pretty much comparable to "free money". The interest rates are so low! The only thing remaining is that you'd still need to pay back the principal.

If you steadily pay your mortgage, then one day it’ll be all done – quite a happy moment. However, if you want to suddenly pay off your mortgage for whatever reason, there may be contractual consequences you hadn’t thought of.

Paying off a mortgage early, isn’t that every home-owner’s dream? You might have saved up money, sold another asset, acquired some other sort of asset or whatever … you no longer need to borrow all that money to finance the house. Therefore, you want to pay off the loan and stop paying interest on all that money you were borrowing. Financially, this makes total sense.

The most common reason why people need to pay off their mortgage is when they sell their house. Strictly speaking, that’s the same situation. Stronger yet, in order to even be ABLE to sell the house, the mortgage must be paid off in full. After all, the new owners will put on their own mortgage and likely aren’t interested in taking over your mortgage loan. In such situations, you may still run into a mortgage prepayment penalty.

A mortgage contract is quite lengthy and includes all the things that you must do to remain in good standing with the bank but also a number of mortgage privileges.

WHAT IS A MORTGAGE PRIVILEGE

Most financial institutions will offer partial mortgage prepayment privileges; these have been in the news lately. However, very few people use them. The few people that use them, often feel that the privileges aren’t generous enough. What’s going on here?

A partial prepayment privilege means that one can prepay part of the mortgage before the mortgage is due and without penalty. Many decent mortgages come with at least 10% lump-sum prepayment privileges; many also allow borrowers to increase their regular payments. The obvious result of either action is that the mortgage loan gets paid down faster. Some financial institutions offer larger pre-payment privileges which may be interesting for some borrowers – but not for many.

If we go back to the amount of the average Canadian mortgage (currently about $151,000), then a typical borrower can prepay at least $15,000 per year in lump sum(s) with no penalty. Obviously, when a mortgage is bigger, the available amounts of the prepayment also go up. When one has a mortgage contract that allows a greater prepayment percentage, the amount would be quite a bit more significant. For instance, a $500,000 mortgage loan (not uncommon around here) would provide room for a $125,000 prepayment in any one year, in combination with a 25% prepayment privilege (such as offered by certain banks like ING Direct). If you are in the position to prepay even a small part of your mortgage, it might be a financially prudent move that’ll snap years of the end of your loan.

When you have the money available and not working for you, it might be a splendid idea to put some towards your mortgage principal now.

OUR PREPAYMENTS STATISTICS

The fact is that most Canadians don’t even come close to paying anything extra on their mortgage over the course of a year. Only one in 6 mortgage holders made any lump-sum prepayments at all in 2011. Those who did, likely prepaid an average of about 8% of their mortgage balance over the course of the year. This, according to the latest details provided by the Canadian Association of Accredited Mortgage Professionals. It’s therefore safe to say that most people will never max out their prepayment privileges.

Making a big prepayment is basically an impossibility for most mortgage holders. They don’t have the money – and if they ever had the money they would’ve borrowed less or purchased a more expensive property. Very few people will find themselves in a situation where they suddenly have the ability to pay off a big part of their mortgage.

Mathematically, those with very small mortgages would be most likely to be able to make maximised prepayments. Other situations would be cash windfalls (inheritance, lottery, gift), big business bonuses, the sale of other assets (real estate, stocks, holdings, business) or even a full personal financial restructuring.

There can be various reasons why you'd want to "break" your mortgage and pay it off entirely - usually however this is because the house was sold.

COMPLETELY BREAKING THE MORTGAGE

There is a difference between prepaying a mortgage and breaking it completely. A prepayment falls within the percentage allowed in the mortgage contract and will not attract a penalty. However, the breaking of a mortgage (prepayment of the entire mortgage principle) will incur a penalty charge that can run into the Thousands of Dollars.

If one is smart enough (and has the means) to prepay that part of the mortgage that falls within the no-penalty portion of the loan, then the principal part of the mortgage will also suddenly be less and therefore attract a smaller mortgage penalty. This would be prudent financial strategy that is completely legal and within the meaning of the mortgage contract.

When a bank offers generous prepayment privileges to a borrower, they have to build in a small financial risk buffer to absorb the financial cost of that facility. In the financial world, nothing is free. Although the bank will not specifically state this, one pays an ever-so-slight premium to be allowed the prepayment privilege. It’s like everything else: something for something. All other mortgage features being equal, a borrower may be more interested in a slight interest rate reduction than in a generous prepayment privilege. Then again, some borrowers might be extremely interested in these prepayment privileges, for instance if they are expecting major financial changes in their lives. The moral of the story is to not overpay for extra prepayment options, unless you anticipate having a use for them.

Is this a boring topic, to write and read about mortgage? Not at all ... the more you know about it, the more interesting it will get.

MORE financially inspired blog articles can be found here by clicking any of the following links:

Who knows of mortgage fraud? http://www.mennorealty.ca/Blog.php/off-the-rails

Enjoying the low mortgage rates: http://www.menno.ca/?p=19448

The Canadian 80% rule: http://www.mennorealty.ca/Blog.php/80-or-81percent

About refinance and renewal: http://www.mennorealty.ca/Blog.php/renewal-1

Lowest Canadian mortgage rates: http://www.mennorealty.ca/Blog.php/buy-more-lowrates