Optimizing the Timing and Amount of Your Lump-Sum Payments

The lump-sum payment is a powerful tool for reducing the total cost of your mortgage, but its effectiveness depends heavily on timing and amount. A well-planned lump sum can generate remarkable savings. Here is how to maximize the impact of every dollar paid as prepayment in Quebec.

Why timing makes all the difference

Early in amortization, the majority of your regular payment goes to interest. On a $300,000 loan at 5% over 25 years, the monthly payment is about $1,745, of which $1,250 goes to interest in the first month and only $495 to principal. A $10,000 lump sum in year 1 directly eliminates that amount from principal, reducing the interest calculated each month for the remaining 24 years. The total interest savings is about $14,000, a 140% return on your payment. The same lump sum in year 15, when the remaining principal is lower and the residual duration shorter, saves only about $3,500. The lesson is clear: every dollar paid early works much harder for you.

Optimal strategy for lump sums

1. Make the lump sum as early as possible in each contract year: Prepayment privileges reset at each anniversary date. A lump sum paid the day after the anniversary benefits from 12 full months of interest reduction, compared to a lump sum paid the day before which benefits from only one month.
2. Use the maximum allowed by your privileges: If your contract allows 15% of the original balance, or $45,000 on an initial $300,000 loan, aim for that maximum. Even if you cannot reach the cap, every amount paid generates proportional savings.
3. Combine with accelerated bi-weekly payments: The combined effect of accelerated bi-weekly and annual lump sums is remarkable. Accelerated bi-weekly ensures continuous extra repayment, while the lump sum provides a major boost once per year.
4. Prioritize higher-rate debts first: Before making a mortgage lump sum, ensure you have paid off higher-rate debts: credit cards at 19-21%, personal loans at 8-12%, unsecured lines of credit at 7-10%. The guaranteed return on mortgage prepayment is your mortgage rate, about 4-6%.
5. Plan your lump-sum sources: Identify recurring sources for your annual prepayments: work bonus, tax refund, thirteenth month from accelerated bi-weekly, inheritance, or asset sales. Automate if possible.

Lump sum vs investment: the calculation to make

The decision between prepaying the mortgage and investing the surplus rests on a simple but nuanced calculation. The guaranteed return on mortgage prepayment is exactly your rate, for example 5%, after tax, with no risk whatsoever. For an investment to be more advantageous, it must generate an after-tax return above 5%. If your marginal tax rate is 45%, an investment must yield at least 9% gross to beat prepayment. A hybrid strategy often recommended is to maximize RRSP contributions to get the tax deduction, then use the tax refund as a mortgage lump sum. An AMF-certified broker helps you plan your lump sums to maximize impact on the total cost of your mortgage.