Compound Interest

Compound interest not only involves interest on the amount borrowed, but also includes interest charged on the interest. When saving money, compounding is a positive accelerator of the saving process since it builds the balance more rapidly.

When borrowing funds, compounding becomes a debt accelerator. The more frequent the compounding period, based on the same loan amount, interest rate and amortization period, the more it costs you. The interest rate on a typical fixed-rate Canadian residential mortgage (conventional mortgage) is compounded semi-annually.

The Federal Interest Act restricts compounding on residential mortgages with blended monthly payments of principal and interest to annual or semi-annual calculations. Not surprisingly, most mortgage lenders offer the semi-annual option because it favours them.

There are several strategies to help you save money on your mortgage beyond the interest rate:

• Start with a shorter amortization period and decrease the period on each renewal date.
• Increase the frequency and/or size of your payments.
• Pay down the mortgage with lump sum payments whenever possible.
• Deduct mortgage interest for the portion of your home used for a home-based business.
• Use a mortgage to raise funds for investment purposes and turn mortgage interest into an income tax deduction.