How to make extra mortgage payments — and why it pays off

Why prepayment is the highest-return safe move for most Canadians

Every dollar you prepay against a mortgage saves you the interest you would have paid on that dollar for the rest of the amortization. On a 5% mortgage with 25 years remaining, $1,000 prepaid today saves you ~$770 in lifetime interest.

That's a 5% guaranteed, after-tax return — because mortgage interest isn't tax-deductible for principal-residence mortgages in Canada. Compare to GICs (3-4% pre-tax) or balanced portfolios (4-6% pre-tax with risk). For most borrowers in the 30-43% marginal bracket, prepayment is the highest-return safe move available.

The catch: you have to actually do it.

The two prepayment levers

Canadian closed mortgages typically give you two prepayment privileges, available each year of the term:

1. Lump-sum prepayment

A one-time (or multiple) lump-sum payment against the principal, in any single calendar year:

• Big-5 banks: typically 15% of the original principal per year
• Monolines (MCAP, First National, Merix): typically 15-20%
• Credit unions: often 20%
• CIBC HomePower / BMO ReadiLine HELOC-style: 20% on the closed component

Some lenders let you double-up: missed payments from a previous month + a lump sum together in the next month, both penalty-free.

2. Payment increase

You can increase your regular payment by up to 15-20% (depending on lender) each year. The extra goes 100% to principal. You can decrease it back later if your cashflow changes.

This is the "set and forget" wealth builder. A small increase compounded over 25 years has dramatic effects.

What it saves — worked example

$720,000 mortgage at 4.84% on a 25-year amortization. Compare three strategies:

| Strategy | Lifetime interest | Years to payoff | |---|---|---| | Standard monthly | $517,200 | 25 years | | +$5,000 annual lump sum | $447,000 | ~20 years | | Accelerated bi-weekly + $5k/yr lump | $410,500 | ~18.5 years | | Standard monthly + 10% payment increase | $445,000 | ~21 years |

Each strategy saves between $70,000 and $107,000 of interest and 4-7 years of amortization. None of them requires breaking the mortgage or changing lenders.

Where to find the prepayment money

The four common sources for most Canadian borrowers:

• Annual bonus or year-end variable comp — hit the lump-sum limit once a year
• Tax refund — typically $2,000-$8,000 for most middle-income filers
• RRSP refund deployed — contribute to RRSP, get the refund, prepay the mortgage
• Side income or freelance — quarterly lump sums

The trick is to AUTOMATE so the prepayment happens before you spend the money on something else. Set up:

• Monthly bi-weekly increase via your lender's online banking
• Annual auto-debit from your bonus account
• Standing order to move tax refund directly to mortgage

When prepayment IS the right move

• You have an emergency fund (3-6 months expenses) already in place
• High-interest debt (credit cards, payday loans) is already cleared
• You've maxed your TFSA + FHSA + RRSP employer match
• Your mortgage rate is 4%+ — the prepayment math gets more compelling as rates rise
• You're aged 30-55 with predictable cashflow

When prepayment is NOT the right move

• You don't have an emergency fund yet
• You're carrying credit card debt at 18-22%
• Your employer match on RRSP is sitting unmatched (free money first)
• Your mortgage rate is sub-3% AND you have 25+ years to retirement (long-horizon equities likely win)
• You might need the cash for a near-term major expense (renovation, business launch, family event)

The tax angle

Mortgage interest on a principal residence is not deductible in Canada (one of the few areas where Canadian tax rules differ from US rules). This is why prepayment is more attractive in Canada than in the US — every dollar of interest saved is a dollar of true after-tax savings.

The major exception: the Smith Manoeuvre structure, which converts non-deductible mortgage debt into deductible investment debt over time. It's complex and only worth doing for higher-income borrowers with a long time horizon. Talk to a tax professional before attempting.

What lenders limit

Most A-tier closed mortgages limit you to:

• 15-20% of ORIGINAL principal per year (not current balance) — so a $720k mortgage allows $108k-$144k of lump-sum prepayments per year, more than most borrowers can deploy
• 15-20% payment increase per year — cumulative over the term

The original-principal basis is generous. Most borrowers never come close to the limit.

The lifetime cap on prepayment privileges is typically: total prepayments cannot exceed the original mortgage. After that, you're paying off the mortgage entirely, which would trigger penalty if done by lump sum within term.

Tracking your prepayment

Most lenders' online banking shows:

• Original principal
• Current balance
• Year-to-date lump-sum prepayments
• Current payment vs maximum allowed payment
• Lifetime prepayment privilege used

Check before making a large lump sum to confirm you're within the limit.

What to do next

1. Confirm your specific lender's prepayment privileges (call or check your mortgage commitment letter)
2. Set up an annual reminder for the lump-sum window (most lenders allow lump-sums on the anniversary date of mortgage)
3. Decide your strategy: annual lump only, payment increase only, or hybrid
4. Run your scenario through prepayment savings calculator
5. If you're going hybrid, also turn on accelerated bi-weekly (see biweekly vs monthly)

Prepayment privileges are the most underused wealth-building tool in Canadian mortgages. The math is straightforward, the execution is simple, and the long-run savings are dramatic.