The implications of amortization

One of the many things that you’ll have to decide when getting a mortgage is the length of your amortization period.
The amortization period of any loan is the amount of time that it will take for you to pay back the loan, given your current interest rate and monthly payments. It is not to be confused with your mortgage term, which is the period of time that your current agreement with your lender will remain unchanged. One easy way to think about it is that a term is generally going to be on the shorter side – it’s often somewhere between one and five years, although seven- and 10-year terms do exist. An amortization period, however, is going to be on the longer side, ranging from 10 years to 25 years. In the States, your mortgage term and your amortization period can be the same; in Canada, you will be forced to renew and/or renegotiate your mortgage at least once over the amortization period, and most Canadians will do so at least three or four times, simply because the terms are much shorter.
The long and short of it
The longest amortization period that you can get in Canada is for 35 years, but that’s not available to everyone, nor is it available for all types of mortgages. In fact, very few homeowners actually have this option and generally speaking, you need to go to a smaller lender to get it, as bigger lenders won’t give it to you. If you need mortgage insurance, then the longest amortization period available to you is 25 years. In other words, people with 35-year amortization periods have mortgages where they made more than a 20 per cent down payment, or purchased homes worth more than $1 million. If you have anywhere from a five per cent to a 19.99 per cent down payment, then the longest amortization period you can get is 25 years.
Strength, not length
We associate longer amortization periods with lower mortgage payments, and that part is true; the longer that you have to pay a set amount, the less that each of those payments will be compared to paying that same amount over a shorter period of time. For many people looking to buy a home, though, the overall purchase price is little more than numbers on a piece of paper. What really matters is that monthly mortgage payment, and because of that, it makes sense that many people want the longest amortization period available to them so that they can get their monthly mortgage payments as low as possible. If it’s an affordability question, then the number of years in the amortization period can make the difference between buying a home and staying out of the housing market.
Low payments are great, but what some people fail to think about is that the longer your amortization period, the more you’re going to end up paying because interest is added to every payment. As you start the repayment schedule for most mortgages, a portion of the payment is put toward the principal and a portion of the payment is put toward the interest. At the beginning, a greater portion of the payment goes toward the interest. Over time, the principal amount decreases, so you’re paying less interest on that amount, and more of the payment goes toward the principal. Another way to look at the difference between a 20-year amortization period and a 25-year amortization period is that you’ll keep five years’ worth of interest payments in your pocket. Let’s look at what that means in real terms.
Using our mortgage calculator, you can calculate the difference that amortization periods make on a $375,000 mortgage.
Mortgage amount Amortization period Interest rate Monthly payment Total interest
$375,000 10 3% $3,621.03 $59,523.60
$375,000 15 3% $2,589.68 $91,142.40
$375,000 25 3% $1,778.29 $158,487.00
As you can see, the difference between a 15 and 25 year amortization period is $67,345. The difference between a 10 and 25 year amortization period is almost $100,000. Of course, there’s also a big jump in monthly payments that you need to be able to shoulder depending on how short of an amortization period that you want to get.
Since the amortization period is the amount of time it will take you to pay off your mortgage, the longer the amortization period of your mortgage, the longer you’re going to have that mortgage, right? Not necessarily. Even with a 25-year amortization period, there is a possibility that you can pay off your mortgage in a shorter time frame if you make additional payments, whether that means increasing the frequency of payments or making additional payments, called lump sum payments. You’ll have to check your mortgage contract, however, to make sure that you’re not violating any stipulations when it comes to the amount of additional money that you’re throwing at your mortgage. Unless you have a completely open mortgage, where you can pay off the principal at any time, there are likely to be some restrictions in place surrounding how often you can throw money at your mortgage, and how much that amount can be. It’s in the best interest of the lender to keep your mortgage on the books for as long as possible because the interest payments keep making them money, so they don’t necessarily want you to pay off your mortgage any earlier than planned.
That being said, there are some benefits to having a long amortization period. One of the biggest reasons that you may want to secure as long of an amortization period as possible is to take any extra money and invest it in other vehicles that will get you better returns, rather than putting all of your extra cash toward your mortgage. Yes, that will mean that you’re accruing more interest on your principal in the long run, but mortgage interest rates are so low that you could be making a bigger profit if your money is in other investments, and that profit could end up being greater than any extra interest on your mortgage. Another reason that someone might want to have a long amortization period is because all debt isn’t created equal, and if they have unsecured or high interest consumer debt, they want to pay it down. If you have $15,000 worth of debt with a 20 per cent interest rate, it’s much more advisable to use any spare cash to get rid of that debt than to pay down your mortgage, which is carrying a 3 per cent interest rate. That $15,000 will swell much faster than your mortgage debt will dwindle.
Make changes
You are not married to your amortization period. Each time you renew and/or renegotiate your mortgage, you have the chance to change it. So if you were on a fixed income or had childcare costs when you first got your mortgage but at the end of your term have much more flexibility in your budget, you can shorten the length of your amortization period at that time. Renewals and/or renegotiations can cause anxiety in some homeowners, but it’s really a chance for you to keep abreast of the best deals available to you at the time, and to match those deals with your current economic situation.

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