The amortization is the total length of time (in years) that it would take to pay off the debt completely. When applying for a home mortgage loan, a borrower has the option of either going for the short or long-term amortization. Short term amortizations usually range from 3-5 years. Longer amortizations used to be at maximum of 30-35 years. However, recent policies have placed long-term amortization for non-insured mortgage at 25 years.
It is common knowledge that the biggest drawback of long-term amortizations is that such an option will make a borrower spend more. Yes, during the course of time, it will cost more even if a borrower will make smaller monthly payments. The following reasons explain why long amortization plans are costlier than short-term ones:
Interest rates are higher: current interest rates as implemented by private lenders and banks are seen in the range of 5% – 8.75%. Furthermore, approvals on long-term loans often come with the condition that interest rates are locked for the entire duration of the mortgage. This means that there is less flexibility in the plan even if market conditions become favorable and average interest rates drop. The high rates of interest are an assurance that the money of the lender is protected. With the 20 or 30-year plan, the lender would have to wait longer for his or her money to be returned. Lenders also consider loans with longer amortizations as a risky transaction.
The money paid towards interest could exceed the principal: take for example a loan amount of $300,000 released at a 5.1% rate. If a 25-year amortization plan is applied to it, the total accumulated interest would be $228,580. However, add another 5 years to the amortization length and the amount paid towards the interest could reach $339,659. This is money that could have been of use for the other needs of an individual.
The possibility of incurring penalties is higher upon breaking on the mortgage: Let’s face the truth: 25 years is a long time to pay off a mortgage. There will always come a time wherein a borrower will want to have his or her debt paid off completely. Penalties that would have to be dealt with can be quite heavy on the pockets of borrowers. Let us take the case of a 10-year mortgage loan taken from CIBC at a fixed rate of 7.85%. If the borrower still has an existing balance of $150,000 and decides to break the mortgage after only 3 years of payment, the penalty would amount to about $9,710. This will be paid in addition to the remaining balance of course.
If you are planning to buy a house and you’re confronted with the need to decide between short and long-term amortization loans, explore your options further. Both plans have pros and cons that would apply to every specific borrower scenario and capability to pay.
Searching through long lists of offers is quite exhausting. Experts recommend examining or visiting no more than 3 houses for sale per day. This way, enough time can be allocated to wise decision making. Through this too, an individual could prevent his or her emotions from taking over when making final decisions on what to buy.
Availing of mortgage loans with longer amortizations undoubtedly cost more but it allows a borrower to enjoy more of his or her net pay per month. Savings on monthly payments could also be placed towards other investments. Whatever the case may be, more time should be allocated to thinking whether one should go for long-term amortizations or not.
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