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Mortgage Amortization – What You Need to Know

Mortgage Amortization – What You Need to Know

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Choosing the right amortization period is crucial when selecting the ideal mortgage. While many focus on the mortgage term due to its impact on interest rates, the amortization period plays a significant role too. Despite its longer duration, it’s a vital aspect to ponder whether you’re purchasing your first home, second home, or are renewing your mortgage.

With today’s higher interest rates, a longer amortization will decrease your payments so it may seem like a good idea. But, there are pros and cons to different amortization lengths. Let’s look at the options and see if long or short is the best choice for the mortgage you apply for when you purchase your home or renew your existing mortgage.

But, First What Is Amortization?

Amortization sounds like a scary term among others you hear when applying for a mortgage. In short, when you amortize a loan, you literally “kill it off” gradually by paying it down in installments. The amortization period for a mortgage is the number of years overall you have to pay back your mortgage loan in full. The length of your amortization period is a critical choice since it directly impacts the amount of interest you’ll pay throughout your mortgage’s lifespan. While the standard amortization period has traditionally been 25 years, shorter or longer options are also available.

What Is The Difference Between a Long And A Short Amortization?

When deciding on your mortgage amortization period, it’s crucial to consider the significant distinctions between shorter terms (ranging from 5 to 15 years) and longer terms (such as 25 or 30 years). For CMHC insured mortgages, the maximum amortization period is 25 years, while for non-CMHC insured mortgages, it extends to 35 years. A CMHC mortgage typically involves a down payment of less than 20% of the purchase price. While the standard amortization period is typically 25 years, borrowers have the flexibility to choose any period within this limit (e.g., 7 years, 22 years, etc.) based on the restrictions of the lender’s mortgage loans.

Why Would You Want A Short Amortization Period?

Choosing a shorter amortization period has its perks: you’ll pay off your mortgage faster, spending less time making payments. This means you’ll shell out less in interest overall and own more of your home sooner. Home equity, which is what you truly own of your home, is what’s left after subtracting your remaining mortgage from your home’s value.

Shorter amortization periods also let you take advantage of lower interest rates. For instance, if you opt for a 25-year plan with a 2.99% rate for the first few years, but it jumps to 4.99% later, your payments will hike up, and you’ll pay more in interest. But if you chose a 5-year plan, you’d stick with the lower 2.99% rate throughout. However, keep in mind that with shorter plans, your monthly payments will be much higher.

Short-term mortgages suit those eager to clear their mortgage fast and can handle a larger minimum payment and less flexibility. If that doesn’t work for you, you can still speed things up by using your prepayment options, usually around 15-20% of your mortgage each year. Ultimately, paying more means reducing your mortgage time and saving on interest.

Why Would You Choose A Long Amortization Period?

Opting for a mortgage with a longer amortization period brings a significant advantage: reduced monthly mortgage payments. This can be a game-changer, especially if your income varies from month to month if you’re managing a hefty mortgage, or if you’re jumping into homeownership for the first time. Additionally, longer amortization periods can open doors to pricier homes, as they boost your chances of securing approval for a larger mortgage.

Extended amortization periods are a smart move because they help minimize risk. With lower monthly payments, should you face unexpected job loss or illness, managing your finances becomes more feasible compared to the higher payments associated with shorter amortization mortgages.

Many first-time homebuyers feel the strain of shorter amortization plans on their finances. It’s tough to gauge how much you can comfortably allocate to mortgage payments until you’ve settled into your home and have a handle on other monthly expenses like utilities. Remember, while you can always pay more, you’re locked into the minimum contractual payment. Opting for a longer amortization period eases the financial burden, providing wiggle room to cover additional household expenses beyond the mortgage.

A longer amortization period doesn’t just aid in homeownership dreams; it allows you to prioritize paying off higher-interest debts like credit cards, bolstering your retirement fund, or allocating more to your usual living expenses.

Shortening Your Amortization Period

If a longer amortization period seems like the best fit for you when you initially buy your home, but your financial circumstances change, you have options. You can easily shorten your amortization by upping your regular payments or making a lump sum contribution towards your mortgage principal. Also, when it’s time to renew your mortgage, you can shorten your amortization period. Shortening your amortization or making lump sum payments not only lowers the total interest you’ll pay but also fast-tracks your journey to mortgage-free home ownership.

What Do The Numbers Look Like?

The median selling price for a detached home in Barrie is about $750,000. Let’s look at this example using my mortgage calculator, assuming a 5.00% interest rate on a variable rate mortgage, a 20% down payment of $15,000, and monthly payments.

  • Monthly payments with a 30-year amortization work out to $3,221, making that total payment after the mortgage is 100% paid off $1,159,560
  • Monthly payments with a 25-year amortization work out to $3,508, making that total payment after the mortgage is 100% paid off $1,052,400
  • Monthly payments with a 20-year amortization work out to $3,960, making that total payment after the mortgage is 100% paid off $950,400
  • Monthly payments with a 15-year amortization work out to $4,745, making that total payment after the mortgage is 100% paid off $854,100
  • Monthly payments with a 10-year amortization work out to $6,364, making that total payment after the mortgage is 100% paid off $763,680

As you can see in the example above, the difference between a 10-year amortization period and a 30-year amortization period is almost double. While a 25-year mortgage allows you to pay $3,508 per month, which is $2,856 less per month than with a 10-year mortgage, you also end up paying $395,880 more for the same house if you choose to spread your mortgage over 30 years.

Why Are 30-Year Amortizations Gaining Popularity?

In recent years, the CMHC has implemented new regulations specifying that homebuyers with less than a 20% down payment are now limited to a maximum amortization period of 25 years. Consequently, those aiming for a 30-year amortization will no longer qualify for mortgage insurance. Generally, a 30-year mortgage is only attainable with a down payment of at least 20% of the home’s price or if you possess 20% equity in your existing property.

Despite being confined to specific mortgage types, the appeal of 30-year amortizations is on the rise. This surge in interest for “extended amortization” mortgages is fueled partly by the substantial increase in home prices over the last decade, outpacing the average Canadian’s income growth. As a result, many prospective first-time homebuyers find it challenging to afford the monthly payments linked to mortgages with even 25-year amortization periods.

Also, Canadians are burdened with higher levels of debt than ever before, driven by factors like student loans, the escalating cost of living, high interest credit card balances, and poor spending habits. This increasing debt load reduces the funds available each month for mortgage payments and limits the amount a new homebuyer has to spare for everyday expenses.

Which Amortization Option is Best for You?

Everyone’s financial situation is different, so the only way to know which mortgage is best for you is to sit down and crunch the numbers. As an experienced mortgage broker, I can review your financial situation with you and help you decide which amortization period is best suited to your unique situation and needs. 

Whether you’re just getting into the mortgage market or are facing a renewal, knowing how amortization works will help you make an informed decision. If you want to know what the lowest interest rate possible is for your mortgage, I can show you the best solution with the most favourable mortgage options and amortization period. Book a consultation with me at this link or give me a call directly at 705-315-0516. We’ll find a mortgage option you’re comfortable with and  get you locked in before rates increase any further.

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