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.

Please contact us if you have any further questions regarding compound interest and how it can effect you.