Mortgage Term vs. Amortization

When diving into the complexities of homeownership in Canada, understanding the distinction between mortgage term and amortization period is essential. These two concepts play a crucial role in determining how much you’ll pay over the life of the loan and how long it will take to pay off your mortgage entirely.

What Is a Mortgage Term?

A mortgage term refers to the length of time your mortgage agreement with your lender is in effect. In Canada, the most common mortgage terms range from 1 to 5 years, with 5 years being the most popular. At the end of the mortgage term, you’ll need to renew your mortgage contract, renegotiate the interest rate, or switch lenders if you find better terms.

Key characteristics of a mortgage term:

• Defines your mortgage rate (fixed or variable).
• Determines your monthly mortgage payments during the term.
• Offers flexibility to change terms at renewal.

Homeowners often choose a fixed rate mortgage for stability or a variable rate mortgage to potentially benefit from lower interest rates.

What Is an Amortization Period?

The amortization period is the total length of time it will take to pay off your mortgage in full. This includes all monthly payments of both principal and mortgage interest. In Canada, the most common amortization period is 25 years, but some borrowers opt for 30 years for lower monthly payments.

Key aspects of the amortization period:

• Affects the total interest paid over the life of the loan.
• Shorter amortization periods result in higher monthly payments but less interest paid overall.
• Longer amortization periods offer more affordable monthly payments but extend the time it takes to become debt free.

Comparing Mortgage Term and Amortization Period

To fully grasp the difference between a mortgage term and an amortization period, consider this example:

• A borrower may choose a 5-year mortgage term within a 25-year amortization period.
• During the 5-year term, they’ll make fixed or variable monthly mortgage payments.
• After the term ends, the mortgage must be renewed until the full 25-year period is completed.

While the mortgage term dictates short-term payment conditions, the amortization period affects your long-term financial planning.

How Amortization and Mortgage Terms Impact Your Payments

The interplay between amortization and mortgage terms significantly shapes your monthly payments and long-term financial strategy. Check out how it impacts your payment.

Shorter Mortgage Terms:

• Often paired with lower interest rates.
• Provide more frequent opportunities to adjust your loan terms.
• May encourage additional payments to reduce the remaining principal faster.

Shorter Amortization Periods:

• Help you become mortgage-free sooner.
• Reduce the total amount of interest over the life of the loan.
• Typically results in higher monthly payments but save money in the long run.

Longer Amortization Periods:

• Offer lower monthly payments.
• Allow borrowers to qualify for larger loan amounts.
• Increase total interest paid.

How Mortgage Terms and Amortization Affect Your Budget

It’s essential to consider the following when choosing your mortgage term and amortization period:

• Down payment: A larger down payment can reduce your total loan amount and impact the amortization schedule.
• Property taxes and homeowners insurance: These costs are not part of your monthly mortgage payment but should be factored into your overall budget.
• Interest rates: Higher rates can increase your total monthly payments and overall loan cost.

Benefits of Aligning Mortgage Term and Amortization Period

Finding the right balance between your mortgage term and amortization period makes good financial sense. Here’s why:

• Aligning a short-term fixed-rate mortgage with a shorter amortization period ensures stability and faster repayment.
• Opting for longer loan terms during economic uncertainty can offer more flexibility.

Additionally, tools like an amortization calculator can help estimate your total monthly mortgage payment, the principal balance, and how much interest you’ll pay under different scenarios.

Strategies to Pay Off Your Mortgage Faster

Paying off your mortgage faster is a financial goal for many homeowners, as it reduces the total interest paid and helps you achieve financial freedom sooner. Here are some effective strategies to help you get there:

Making Additional Payments:

• Extra payments go directly toward reducing the principal balance, shortening the amortization period.

Lump Sum Payments:

• Many mortgage contracts allow annual lump sum payments without penalties.

Switching to a Shorter Amortization Schedule:

• Reducing the amortization period can significantly lower the total interest you pay.

Refinancing Options:

• Refinancing an existing loan into a shorter term may help accelerate your journey toward becoming debt-free.

Longer Amortizations…Why Do They Cost More?

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 short or long-term amortization.

Short-term amortizations usually range from 3-5 years. Longer amortizations used to be at a maximum of 30-35 years. However, recent policies have placed long-term amortization for non-insured mortgages 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 makes 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.

Final Thoughts

Understanding the relationship between mortgage term and amortization period is crucial for Canadian homeowners. Whether you prioritize lower monthly payments, becoming mortgage free sooner, or minimizing total interest costs, aligning these two factors with your financial goals will ensure you make the best decision for your future.

Using tools like an amortization calculator and consulting experienced mortgage lenders can provide clarity and help you navigate the complexities of the Canadian housing market with confidence.