Think you’re stuck with your mortgage for 25 years? Think again. What if I told you there may be hidden tools within your mortgage agreement that could save you tens of thousands of dollars—and shave years off your mortgage payment timeline? Even more important than your mortgage rate, these are the secrets the bank doesn’t advertise.
Ready to save a lot of money? Let’s put the puck in the net.
What is a Prepayment Privilege?
Accelerated Payment Privileges
Getting Mortgage Free
Have you ever dreamed of being mortgage-free faster? Prepayment privileges are the ultimate weapon for saving money on your mortgage. More than your mortgage interest rate, they let you pay off your loan faster, cut down on interest, and gain financial freedom sooner—all without penalties.
But here’s the catch: not all mortgages are created equal. From 10 and 10 options on low-rate mortgages to 20 and 20 plans, your lender’s terms could either help you save a fortune or keep you locked in longer than you’d like. In this article, I’ll cover everything you need to know about prepayment privileges, why they matter, and how to use them to your advantage.
What is a Prepayment Privilege?
Mortgage prepayment privileges are an essential feature that can significantly impact the cost and flexibility of your mortgage. A mortgage is a contract that says you will pay back a loan at a defined interest rate over a defined period of time. A prepayment privilege allows you to marginally break that contract by paying off the mortgage principle sooner, thereby lowering the total amount of interest you will pay and shortening the length of the mortgage. Lenders provide this option to attract borrowers to their products, as the mortgage market is very competitive. Without prepayment privileges, a borrower must pay substantial penalties to make any adjustment to the payment schedule.
These privileges allow you to pay down your mortgage principal faster, either through lump-sum payments, increased monthly payments, or both, without incurring penalties. By reducing the principal, you lower the amount of interest accrued over time, which can save you thousands—or even tens of thousands—of dollars over the life of your mortgage.
Prepayment options are particularly valuable if you receive bonuses and inheritances, or maybe you have been successful in your budgeting and have been able to free up some cash. Prepayment options enable you to pay down debt faster and achieve financial freedom sooner. However, not all mortgages offer the same prepayment flexibility; some have no prepayment privileges, low-rate mortgages limit the amount you can prepay to 10%, and others do 20 and 20 while offering unlimited prepayment opportunities. Choosing a mortgage with robust prepayment privileges ensures you have the flexibility to adapt to changing financial circumstances and optimize your mortgage strategy.
Open Mortgages
When discussing prepayment privileges, you have to first separate out what kind of mortgages we are talking about.
If you have what is called an open mortgage, you don’t have to worry about prepayment privileges at all, because you have all the prepayment privileges in the world. When you have an open mortgage, you can pay off as much of your mortgage as you want at any time, over and above your regular mortgage payments.
You can get a 1, 2, 3, and 5-year open mortgage, but 1-year open mortgages are the most popular. The nature of an open mortgage is such that, except in unique circumstances, getting more than a 1-year open mortgage doesn’t make much sense because it is the only kind of mortgage that you can get out of at any time, no questions asked!
The downside with open mortgages is they are usually offered on low loan-to-value mortgages, usually no more than 75%. What that means is that on say a million-dollar home, you won’t get a lender to give you more than $750,000.
You can’t, for example, do a high-ratio mortgage using an open mortgage; that’s a mortgage where you put down less than 20%. For example, on a million-dollar home, you’d need to put down more than $200,000. If you can’t put that much down, you’ll need to get a closed mortgage and mortgage default insurance; it’s a legal requirement.
When you do bridge financing, which is the type of financing I can arrange for you where you can hold 2 houses at the same time for a short time. For example, you can buy one house and take possession in June, but not give up possession of your present house until August. This way, you can get your new home ready for you: painting, small renovations, new flooring, whatever. Bridge financing is a kind of open short-term mortgage.
Private Mortgages
Private mortgages are not specifically open mortgages per se, but they have a lot of the same characteristics and are frequently used strategically in much the same way as an open mortgage. Private mortgages and open mortgages are shorter-term mortgages; they are both designed to be interim solutions for borrowers needing quick funds or unable to qualify for traditional financing; they often offer flexible repayment plans without the hefty penalties of closed mortgages; and like open mortgages, private mortgages are offered at high rates.
Private mortgages are more collateral-based lending, meaning that the lender cares more about the ability to sell the house and get their money back if the borrower can’t pay and not as much on things like income and credit score, while open mortgages care more about things like income, debt, and credit score.
And that’s the biggest rub of open mortgages. The rates on open mortgages are substantially higher than they are for closed mortgages but lower than they are for private mortgages. Open mortgages have lower rates than private mortgages, but they also require more stringent loan criteria and underwriting.
But the good thing about open mortgages is that once the reason for getting an open mortgage has passed, most lenders include a convertible feature that allows you to convert your higher-rate open mortgage to a lower-rate closed mortgage.
Closed Mortgages
But when we talk about prepayment privileges, we are really talking about closed mortgages. A closed mortgage is a type of mortgage agreement in which the borrower is restricted from repaying the loan in full, refinancing, or making extra payments beyond a specified limit without incurring penalties, and these penalties are substantial. Closed mortgages are the most common type of mortgage in Canada because they typically offer lower interest rates compared to open mortgages, making them appealing for borrowers planning to hold their mortgage for the entire term, which is the length of time you must ‘obey’ the terms of the mortgage, most popular closed mortgage terms are 3 or 5 years, but they be as short as 6 months or as long as 10 years.
Closed mortgages are offered at lower interest rates compared to open mortgages because they provide lenders with greater certainty and stability in their lending operations. You see, closed mortgages lock borrowers into a specific term, meaning lenders can count on receiving regular payments over that period without the risk of the loan being repaid early. Big penalties for breaking a closed mortgage provide substantial revenue to lenders; penalties our American friends don’t pay, and these penalties stop you from seeking out better rates or switching to other lenders. Then once they have hooked you, they will try to sell additional financial products like credit cards, investment accounts, insurance, etc.
Prepayment Terms
What does this have to do with payments? A mortgage with prepayment privileges usually has those privileges described as 10 and 10, 15 and 20, 20 and 20, and so forth. What do these numbers mean?
The first number describes the maximum percentage of your mortgage you can make an annual, lump-sum payment against. This means you can pay up to 20% of the original principal balance of your mortgage as a lump sum once per year, typically on the anniversary date of when the mortgage started.
For example, if your original mortgage loan was $500,000, you could pay up to $100,000 (20% of $500,000) as a one-time lump sum each year. You don’t have to make the entire $100,000 lump sum payment; you could do as much as you can, up to the $100,000 available at the end of that year. Not only does this prepayment reduce your mortgage principal directly, it lowers the amount of interest you’ll pay over time and gets you to being mortgage-free sooner.
You get to make this lump sum payment without penalties, and some lenders even allow these prepayments at any time during the year (not just on the anniversary), which is awesome.
Then there’s the second number of the 20 and 20, which is the increase in payment on the anniversary date. This means you can increase your regular mortgage payment amount by up to 20% of the original payment amount once per year, typically on the anniversary date.
For example, if your regular mortgage payment is $1,500 per month, you could increase it by up to $300 (20% of $1,500), bringing your new monthly payment to $1,800. The extra amount goes directly toward paying down the principal, reducing your mortgage balance faster, and saving on interest. What’s more, you can do this every year and get the advantage of compounding to drive down your mortgage principle.
If you choose to do this annually, the increased payment amount becomes your new “regular payment,” meaning next year’s allowed increase is based on the higher payment.
Example:
- Year 1 Regular Payment: $1,000 per month.
- Increase at Year 1 Anniversary: +20% = $200 → New Payment = $1,200.
- Year 2 Increase (20%): Based on $1,200 → +$240 → New Payment = $1,440.
With each increase, a larger portion of your payment goes directly toward reducing the principal balance because more principal is being paid off faster. This leads to greater interest savings over time. The compounding effect of these increases means your mortgage is paid off much faster than initially scheduled, even with small annual increases. By reducing the principal earlier, you accrue less interest overall since interest is calculated on the remaining principal balance.
You don’t have to increase your payments; cash flow is a real problem these days, with many clients looking to expand their amortization to lower their monthly payments. But if you can do it, taking advantage of your available yearly payment increases is a fabulous way of saving a ton of money.
Low Rate Mortgages
So we’ve talked 10 and 10, 15 and 20, 20 and 20. Ultra-low rate mortgages with great teaser rates always offer the worst lump sum and prepayment options; they are the 10 and 10. The best mortgages are the 20 and 20 on a slightly higher mortgage rate, but after doing the math and crunching the numbers, you’ll find that most of the time the ultra-low rate is actually more expensive.
Read More: Discover the Risks of Low-Rate Mortgages
Accelerated Payment Privileges
Lastly, when it comes to prepayment privileges, we have to talk about accelerated payments. Depending on your mortgage, you may be allowed the prepayment privilege of changing the frequency of payments. Instead of just paying your mortgage monthly, you could pay it biweekly, which means you’ll make 26 payments a year, not 24. That’s 2 extra payments to drive down your mortgage. You may even be able to make payments weekly and make 52 payments a year. You could go semi-monthly as well. Extra payments reduce your principal faster, lower the total interest charged, and shave years off of your mortgage.
But wait, there’s more. Why just settle for weekly or biweekly when you can go accelerated weekly or accelerated biweekly? Let me explain how this works: for accelerated weekly, you divide your monthly payment by 4, then pay that amount weekly. For accelerated biweekly, divide your monthly payment by 2 and pay that amount every 2 weeks. This results in even more extra payments because a calendar year has slightly more than four weeks per month, leading to additional payments annually and additional savings.
Double Up Privileges
Wow, I can’t believe there are still more prepayment privileges. I thought lenders wanted to lock you in. The last one I want to talk to you about is double-up payments. This is the prepayment privilege to double up your regular mortgage payment whenever you choose. It’s a 2fer! Just like all the other great prepayment privileges, this goes right to reducing your principle. Let’s say your mortgage payment is $3,000 a month and you get a bonus from work. Double up on that mortgage payment, baby! You just bought free and clear another room of your house.
And here’s the thing and where I gotta wrap up: there are lenders out there who let you have it all. Oh, they have names you may not have heard about, but out there, you can get your lump sum annual increase, your regular payment increase, your accelerated payment increase, AND your double up. You are going to be mortgage-free very soon.
And if you can’t take advantage of all your prepayment options available to you, at least you have them, and you can take advantage of them when it is good for you.
Summary
“So, there you have it. Prepayment privileges aren’t just a nice-to-have feature; they’re your ticket to saving money, paying off your mortgage faster, and gaining control of your financial future. From annual lump-sum payments and regular payment increases to accelerated payment schedules and double-ups, these options are designed to give you the flexibility to pay down your principal faster, without penalties.
And remember, not all lenders or mortgages offer the same privileges, so shop smart. The right mortgage isn’t just about the rate; it’s about the terms that work for you. If you’re ready to take control of your mortgage, or if you need help finding a lender that offers the best prepayment options, I’m here to help.
If you are a realtor or financial advisor or planner, and you have more complex mortgage questions as you try to support your clients don’t hesitate to reach out… I work realtor hours.
