Lump-Sum Mortgage Payments: Using Annual Prepayment Privileges

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Most closed fixed-rate mortgage contracts in Canada include a lump-sum prepayment privilege that allows borrowers to make an additional payment directly against the principal, without penalty. This privilege varies by lender but generally ranges from 10% to 20% of the original loan amount per year. For example, on a $400,000 mortgage, a 15% privilege allows up to $60,000 in additional principal per year. This amount is applied entirely to principal, immediately reducing the balance on which interest is calculated. The effect is particularly significant early in the loan, when the interest portion of each regular payment is highest. A $20,000 lump-sum payment made in the first year of a $400,000 mortgage at 5% can save over $35,000 in interest over the life of the loan. Most lenders calculate the privilege based on the calendar year (January to December) or the contract anniversary year. Unused privilege does not carry over from one year to the next. In Quebec, an AMF-certified mortgage broker can verify your exact privilege conditions and advise on the optimal timing for your lump-sum payments.

Lump-Sum Payments: Using Your Privileges to Reduce Your Mortgage

Every closed mortgage contract in Canada contains prepayment clauses that define what the borrower can pay beyond regular payments without incurring a penalty. The lump-sum payment is one of these privileges: it allows the borrower to make an additional payment directly against the loan principal. This amount immediately reduces the mortgage balance and, consequently, the interest calculated in each subsequent period. It is one of the most effective ways to shorten your amortization and decrease the total cost of your mortgage.

How the Lump-Sum Prepayment Privilege Works

Lump-sum prepayment privilege

The privilege amount is expressed as a percentage of the original loan amount. For example, a lender offering a 15% privilege on a $400,000 mortgage allows up to $60,000 per year in additional principal. This amount is generally paid in one or more payments, depending on the lender's conditions. Some lenders require a minimum payment (for example, $100), while others accept payments of any amount.

Concrete Financial Impact

The impact of a lump-sum payment is all the more significant when made early in the life of the loan. On a $400,000 mortgage at 5% amortized over 25 years, a single $20,000 lump-sum payment made in the first year immediately reduces the balance to $380,000. Interest is now calculated on this new reduced balance. In total, this single payment can save over $35,000 in interest and shorten amortization by approximately one and a half years. If the borrower contributes $20,000 each year for five years, the cumulative effect is even more dramatic.

Conditions and Limits to Know

The privilege is annual: it does not carry over from one year to the next. If you do not use it, it is lost for that year.
The calculation basis varies: most lenders calculate the percentage on the original loan amount, which is more generous. Some calculate it on the current balance.
Excess is penalized: any amount paid beyond the privilege is subject to the prepayment penalty (three months' interest or interest rate differential).
Payment methods vary: some lenders accept online payments, others require a phone call or branch visit. Verify the process with your institution.
The regular payment does not change: after a lump-sum payment, your regular payment stays the same. It is the amortization period that decreases. However, some lenders offer the option to recalculate the payment downward.

Frequently Asked Questions

What is the maximum lump-sum payment allowed without penalty?

The amount varies by lender and contract. Most Canadian lenders offer a privilege of 10% to 20% of the original loan amount per year. Some lenders, like Desjardins caisses populaires, may offer up to 15%, while other major banks offer 10%, 15%, or 20%. Check your mortgage agreement to find your exact privilege.

When is the best time to make a lump-sum payment?

As early as possible in the year and in the life of the loan. A payment made in January saves more interest than an identical payment made in December because the reduced principal generates savings over a longer period. Similarly, a payment early in the loan has a much greater effect than one later, as the balance is higher and accrued interest is greater.

Does the lump-sum privilege apply to the original amount or the current balance?

The vast majority of lenders calculate the privilege on the original loan amount, which is advantageous for the borrower. Some lenders calculate it on the current balance. Check your mortgage agreement or ask your broker to confirm the calculation basis.

What happens if I exceed my prepayment privilege?

If you pay more than the authorized privilege, the lender may charge a prepayment penalty on the excess. This penalty generally corresponds to three months' interest or the interest rate differential (IRD), whichever is higher for a fixed rate. Always stay within your privilege limits.

Can I combine lump-sum payments with other accelerated repayment strategies?

Yes, absolutely. Lump-sum payments, increasing the regular payment, and accelerated payment frequency are complementary strategies. You can use all three simultaneously to maximize amortization reduction. Each strategy acts independently on the principal.

Does the privilege carry over if I do not use it one year?

No. With most lenders, the privilege is calculated annually and does not carry over. If you are entitled to 15% per year and use nothing one year, you cannot pay 30% the following year. Each year is independent. Use your privilege when you have available cash.