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Grab the Mortgage by the Horns

Globe and Mail - ROB CARRICK - May 27, 2008

If you bought a home in the past while, there's a no-brainer answer to the question of what to do with this year's tax refund.

Pay down your mortgage. It's the smart move at a time when house prices are sky high and buyers are increasingly relying on long-amortization mortgages that go way beyond the once-standard 25 years.

Making a lump-sum mortgage payment is one of those things people mean to do, but don't often get around to because there are so many competing demands for money. This is especially true if you've recently bought a home.

But tossing even a few hundred dollars down against your mortgage principal can save you a substantial amount of interest and put you on the road to paying off your mortgage sooner.

For people with mortgages with 25-year amortizations, paying a mortgage off early is a non-urgent luxury. You can buy a home in your early 30s, have it paid off by your mid-50s (easy to do if you make accelerated biweekly payments) and then have close to a decade to ramp up your savings for retirement.

In the past couple of years, however, more and more buyers have been coping with high house prices by taking advantage of new mortgage financing options that allow amortization periods to be extended to 30, 35 or 40 years.

With a 40-year mortgage, you could buy a home at 35 and still be paying it off well into retirement. And yet, people are using this mortgage option. There are reports that in high-priced markets like Vancouver and Victoria, 85 to 90 per cent of first-time buyers are going with a 40-year amortization.

Look, you do what you have to do to afford a home in an expensive city. And then you exploit every opportunity to get your mortgage paid off before you're too old to mow your own lawn.

Let's say that you take out a $300,000 five-year mortgage at a rate of 5.25 per cent and an amortization period of 40 years. Using the online mortgage calculator offered by ING Direct, you'd be on track to pay a staggering $412,919 in interest, assuming you make the mistake of making monthly payments.

By choosing accelerated biweekly payments, you can get your interest charges down to just under $311,000. Just as importantly, you get your mortgage paid off in a little under 32 years.

Your tax refund can help you get that 40-year mortgage under control even faster, even if you've got just a few hundred dollars in hand. The ING calculator shows that making a single $500 lump-sum payment on your mortgage can save you $2,066 over the life of your mortgage.

A payment this small won't get your mortgage paid off much faster. But what if you committed $500 from your tax return for annual lump-sum mortgage payments for five successive years? Now, you've got interest savings of $8,959 and you've got your mortgage on track to be paid off in 31 years.

As you'd expect, larger lump-sum payments produce better results. Annual payments of $1,000 over five years get your 40-year mortgage paid off in 30.5 years, with interest savings of $17,577.

With $1,000 payments over 10 years, you get that 40-year mortgage paid off in a little over 29.5 years.

Virtually all mortgages allow you to make lump-sum mortgage payments of up to 10 or 20 per cent of your outstanding principal each year. But there's a better way to use the typical tax refund to pay down your mortgage.

According to the federal Financial Consumer Agency of Canada, most lenders allow you to make what are sometimes called double-up payments, where you double the amount of your regular payment and have the extra go directly to reducing your principal (partial double-ups may be possible). Some lenders let you make as many double-up payments as you want without counting the amount against your annual prepayment allowance.

The benefit here is that you can use your tax return to pay down your mortgage and still have room to make a big prepayment later on should you be lucky enough to get a financial windfall later in the year.

With one of those new extended-amortization mortgages, you have to exploit any opportunity you have to pay off what you owe sooner. Your tax refund is a good place to start.

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