Pre-payment privileges are the single most overlooked aspect of a mortgage by borrowers. Consumers, for whatever reason, seem to gloss over them as if they are a feature of the mortgage that will never be used, and really doesn’t matter, unless you win the lottery.
However, pre-payment privileges are very important. They are what allow you to reduce your amortization from 25 years to 10 years. They can also affect your interest rate and your payout penalty, which is why a better understanding of how they work, is important.
Lets start with the basics. In the past, the standard pre-payment terms for most banks were 20% + 20%. The two percentages represent the amount that your payment can be increased and the percentage of the mortgage that can be paid off without penalty every year.
So, lets say you have a $100,000 mortgage with a $500 payment. Using 20% + 20% privileges you can pay off $20,000 of the mortgage without penalty, and you can also increase your ongoing payment by $100 every year. Pretty simple?
Well here is where it gets difficult. With the highly competitive rate market of years past, many banks have adjusted their pre-payment privileges.
For example, if you search for pre-payment privileges on RBC’s website, the first page you find will say something to the effect of, “you could prepay as much as 20% or more of your original mortgage balance each year.” Dig a little bit deeper however, and what you will find is that they limit both the lump sum payments and the increase a payment options to 10%, which is the lowest of all of the big banks.
What is disheartening is that RBC tries to make it appear as though their pre-payment privileges are competitive with most of the other banks 20% option by having that misleading piece of verbiage on the first page, when in reality they are not competitive at all.
In addition to certain banks having standard pre-payment privileges that are not competitive or misleading, other banks like BMO, have experimented with no frills mortgages that also have lower pre-payment options. The now famous BMO 2.99% mortgage is a fine example. Often, in order to get the best rate, one must forfeit the ability to accelerate the amortization, which can be expensive both in term of interest paid and higher payout penalties.
Of all of the pre-payment options out there, our favorite are the options provided by First National and Scotiabank. They offer 15% + 15% + Double Up. What is double up? It is exactly what it sounds like, it is the ability to double your monthly payment as often as you like.
Unlike the 15% increase your payment option, which once used is permanent, you can use the double up option one payment at a time, or on an ongoing basis if you like. The double up payment combined with the 15% privileges make Scotiabank and First National’s mortgages the best in the industry when it comes to pre-payment. Even better than the 20% + 20% option that was once the norm.
