Right to Prepay Your Mortgage: Privileges and Options

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The right to prepay a portion of your mortgage is a fundamental contractual privilege for every Canadian borrower. Most fixed-rate mortgage contracts include prepayment privileges allowing annual lump-sum payments of 10% to 20% of the original loan amount without penalty. Additionally, borrowers can typically increase their regular payments by 10% to 20% (sometimes up to 100% depending on the lender). These privileges, though often underutilized, represent a powerful tool for reducing total interest costs and shortening the amortization period. For example, on a $400,000 mortgage at 5% amortized over 25 years, an annual prepayment of 10% ($40,000) for three consecutive years could shorten the amortization by several years and save tens of thousands of dollars in interest. In Quebec, the mortgage contract is governed by the Civil Code of Quebec (CCQ), and prepayment conditions must be clearly stipulated. The Autorité des marchés financiers (AMF) ensures that mortgage brokers adequately inform borrowers of these rights. Federally regulated lenders (chartered banks) are also governed by the Bank Act and OSFI guidelines regarding disclosure. It is essential to verify the specific conditions of your contract, as terms vary considerably from one lender to another.

The Right to Prepay: A Powerful Tool for Reducing Your Interest Costs

Among the fundamental rights of Canadian mortgage borrowers, the prepayment privilege is arguably the most underutilized. This contractual right allows you to repay a portion of your mortgage principal beyond your regular payments without penalty. When properly leveraged, it can save you tens of thousands of dollars in interest and shorten your amortization period by several years.

The Two Forms of Prepayment

Annual lump-sum payment: Most lenders allow an annual lump-sum payment of 10% to 20% of the original loan amount. This amount is calculated on the original principal (not the current balance), meaning the eligible amount remains the same throughout the term. For example, on an original $400,000 loan with a 15% privilege, you can repay up to $60,000 per year without penalty.
Regular payment increase: In addition to the lump-sum payment, most contracts allow you to increase regular payments by 10% to 20% (some lenders allow up to 100%). If your monthly payment is $2,400, a 15% increase would bring it to $2,760, an additional $360 per month applied directly to principal. Over a year, this represents $4,320 in additional principal repaid.

Concrete Impact on Your Mortgage

The effect of prepayments is amplified by compound interest mechanics. Every dollar repaid in principal today eliminates the interest that would have been calculated on that dollar for the entire remaining amortization period. On a $400,000 mortgage at 5% amortized over 25 years, total interest costs amount to approximately $296,000. By fully utilizing a 15% prepayment privilege during the first five years ($60,000 per year), you could reduce the amortization period by nearly 10 years and save over $120,000 in interest.

Prepayment Strategies

Combine both privileges: use both the lump-sum payment and the payment increase to maximize your principal repayment. These two privileges are cumulative.
Plan payments early in the term: prepayments made at the beginning of the term have a greater impact because the balance (and therefore the interest) is higher.
Use the anniversary date to your advantage: privileges typically renew on the contract's anniversary date. Plan your lump-sum payments to maximize usage of each eligible period.
Adjust your payment frequency: switching from monthly to accelerated bi-weekly payments generates the equivalent of one extra monthly payment per year, also reducing the amortization.

Frequently Asked Questions

What percentage of my mortgage can I prepay each year?

Most Canadian lenders allow an annual lump-sum prepayment of 10% to 20% of the original loan amount (not the current balance). Some lenders, such as Desjardins caisses, sometimes offer more generous terms. Check your mortgage contract or consult your broker to find out your exact privileges.

Can I increase my regular mortgage payments?

Yes. Most mortgage contracts allow you to increase regular payments by 10% to 20% per year. Some lenders even allow you to double your payments (100% increase). This increase applies directly to principal repayment, significantly accelerating your mortgage payoff.

When is the best time to make a prepayment?

The earlier in the life of the loan, the better. At the beginning of the amortization, a larger proportion of each payment goes toward interest. An early prepayment reduces the principal on which interest is calculated for the entire remaining term. Also check your contract's anniversary date, as privileges typically renew on an annual basis.

What happens if I exceed my prepayment privileges?

If you repay an amount beyond your contractual privileges, a prepayment penalty applies to the excess. This penalty is typically the greater of three months' interest or the interest rate differential (IRD). The penalty can be substantial, especially with a fixed-rate mortgage when rates have dropped.

Are prepayment privileges the same for variable-rate mortgages?

Variable-rate mortgages generally offer more flexibility. Most can be fully repaid with a penalty of only three months' interest (no IRD calculation). Partial prepayment privileges are often similar to those for fixed-rate mortgages, but check your contract for precise conditions.

Can my broker help me consider selecting a lender with better prepayment privileges?

Absolutely. Prepayment privileges vary significantly from lender to lender. An AMF-certified mortgage broker compares offers from multiple lenders and can identify those offering the most advantageous privileges based on your repayment strategy. This criterion should be an integral part of your selection process.