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How Does Amortization Impact Interest Rates?

How Does Amortization Impact Interest Rates?

When buying a home, there are several different paths you can explore when considering which type of mortgage, or loan, is best for you. This is a decision that will impact your finances for many years, and so it’s wise to gather as much information as you can before signing on the dotted line.
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Amidst a myriad of mortgage options, an “amortized loan” is a loan with regularly scheduled payments against your principal – and the interest incurred ­­­– over a number of years. The duration of an amortized loan is called an “amortization period,” and is based on how many years you will need to pay off your mortgage. The standard amortization period is usually 25 years (when your down payment is equal or greater than 20% you can sometimes stretch to 30 or 35 years, if needed).

Regardless of the options, an important thing to keep in mind is that the length of time you choose for your amortization period will directly impact the amount of interest you pay over the lifetime of that loan.

A shorter amortization period means that the mortgage payments you make will be higher than those made over the span of a lengthy amortization period. This is because more of your payment goes towards paying down your principle balance over a condensed amount of time. When you choose the option for a shorter amortization period, you can be mortgage-free sooner, and build equity in your home at a rapid rate. Most importantly, you will pay much less in interest costs over the time period of your loan because you are paying it back relatively quickly.

Some people prefer a longer amortization period, because spreading their mortgage installations out over an extended timeframe lowers the cost of those regular loan payments. However when you choose a longer amortization period, you will pay the principle balance down at a slower rate. This means it also takes a longer period of time to build up of equity in your home – and higher interest rates over the duration of that prolonged amortization period.

In short: the longer it takes you to pay back the mortgage principal to your lender, the more interest you will pay. This can affect your abilities to save for other important things, such as your retirement, or perhaps a college fund for your children. Short amortization periods with lower interest rates are obviously ideal. But for many, a longer amortization period means the difference between buying a home – or not buying one at all. If you need guidance in deciding the best amortization period for you, please give me a call and we can take a look at your individual options to determine which kind of amortization best suits your needs.

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