Mortgage Prepayment Privileges
Regardless of the lender, prepayment rights are generally included with mortgages. However, they are not all created equal, therefore it’s crucial for you to comprehend how the prepayment rights granted by your lender operate.
Prepayment rights let you make a certain amount of interest-free mortgage payments each year. This is in addition to your regular payments.
Your principal will be increased by the full amount of every additional payment you make toward your mortgage. With every single mortgage lender, this will always be the case. On each subsequent regular payment, the principal amount will subsequently rise and the interest component will fall as a result.
UNDERSTANDING YOUR PREPAYMENT OPTIONS
Usually, prepayment advantages are expressed as 15/15 or 20/20. The first figure shows the annual percentage by which you may raise your payments. The second number, which is likewise an annual total, shows the percentage of lump sum payments you are eligible to make.
Let’s take a look at each component in more detail.
Payment Increase Privilege
As an illustration, consider a mortgage with 20/20 prepayment rights. You may do this to raise your monthly payment (or biweekly payment, weekly payment, etc.) by 20% annually. If your mortgage payment was $2,000 per month, you could immediately raise it to $2,400 starting with your first instalment.
Increasing your payment privileges by stacking
The increase in your payment might then be stacked for years after that. For instance, if you made the most of the payment increase privilege, your 5-year term’s payments would be as follows:
- Year 1 – $2,400
- Year 2 – $2,600
- Year 3 – $3,000
- Year 4 – $3,400
- Year 5 – $3,800
The privilege of a 20 percent payment increase in the aforementioned example is based on your initial payment total. Not all lenders operate in this manner; some use the yearly payment increase and then add the additional 20%. If you were to use this approach and reach the maximum amount of your payment increase privilege, the payments would appear as follows:
- Year 1 – $2,400
- Year 2 – $2,880
- Year 3 – $3,456
- Year 4 – $4,147.20
- Year 5 – $4,976.64
Keep in mind that you can only stack payment increases this way if you use them all up each year. The right to a payment increase is not cumulative. For instance, you would forfeit the 20 percent gain for the first year if you didn’t use it. The 20 percent increase would begin in the second year and be computed using the $2,000 starting payment level.
If you just use a portion of the payment increase permission, the subsequent year’s 20 percent will be calculated depending on your usage. For instance, you would only be able to increase your contribution to a maximum of $2,500 in the second year if you increased it to only $2,100 per month in the first year.
Keep in mind that you can typically return to your initial payment at any moment. Some lenders, however, might only allow you to return to the increased payment from the prior year if you maximize your payment increase permission each year. I’ll elaborate a little further.
Let’s use the first example from above and suppose you are in year four. Your current monthly payment is $3,400, but your lender might only allow you to go back to the $3,000 payment from year three rather than the $2,000 payment that you first made. The best course of action is to speak with your mortgage professional to determine the lender’s exact policy on this.
Read Also: Mortgage Prepayment Penalties
Lump Sum Payment Privilege
The annual lump amount % is indicated by the second number in the 20/20 formula. You might pay a lump sum of up to $100,000 per year, for instance, if your starting mortgage balance is $500,000.
The number of times a lump sum payment can be made in a year may be restricted by some lenders. But many people are more adaptable than this.
It doesn’t matter how much of a prepayment you make if your lender only allows you to make one lump sum payment per year.
Fortunately, a lot of lenders don’t have this restriction and let you make as many prepayments as you like as long as they coincide with planned payment dates and don’t go over the annual cap. There are certain lenders who let prepayments at any time, whether or not there is a fixed payment date, but this is quite uncommon.
Keep in mind that the balance used is the “initial” mortgage balance. Therefore, even if you significantly reduced your mortgage balance in the fourth year, the lump sum payment cap of $100,000 still applies.
Combining both lump sum and payment increase privileges
Almost all mortgage lenders will let you make any arrangement of lump-sum payments and payment increases, so long as the total prepayment does not go above the yearly lump-sum cap. For instance, if the maximum lump sum is $100,000, the total of any payment increases and lump sum payments cannot be more than $100,000.
Some lenders, meanwhile, may permit you to entirely max out both.
While some lenders base their calculations on the calendar year, others use the anniversary year, which is the date when you obtained your mortgage.
You’ll frequently see it phrased as 15/15 or Double Up since certain lenders will add a double-up option to their prepayment privileges. You are able to double your payments with this, as the name suggests.
This can be slightly misleading, though, as a lender might not explicitly say that you can double up your payments. If, however, your lender does not have a limit on the number of times you can make lump sum payments, you could be able to exceed doubling your payments.
The amount of your regular monthly payment of $2,262.30 could be increased by an additional $8,333.33, for a total payment of $10,595.63 each month if your lender allows 20/20 prepayment privileges with no restrictions on the number of times you can make lump sum payments. In this instance, your monthly payment has more than doubled!
Just because a lender does not explicitly offer a double-up option does not preclude you from making twice as much in installments.
Prepayment rights may differ from one lender to another. Ask your mortgage consultant to discuss the prepayment privileges in full if paying off your mortgage early is something that is essential to you. Make sure the lender’s policy is flexible enough to allow you to meet your prepayment goals.