Two important components of any mortgage are the amortization period and the mortgage term. Not only do these two factors determine when you’ll become mortgage-free, but they also will help define your overall costs, interest rates and monthly payments.
To put it simply — an amortization period is the total length of time it takes to repay your mortgage, and a mortgage term is the length of time you are locked into a mortgage contract.
Of course, these are just the basics. In practice, it’s a little more complicated, as we explain below.
An amortization period is the amount of time it should take a homeowner to pay off their mortgage in full, based on their current interest rate and payment schedule.
Choosing a shorter amortization period allows you to be mortgage-free sooner. This means you’ll save money on interest over time, but you will likely have higher monthly payments.
Comparatively, a longer amortization period means lower monthly payments but more interest paid during the lifetime of your mortgage. While this may allow you to qualify for a more expensive home, it will take longer to pay off your mortgage.
A 25-year amortization period is standard for most Canadians and the maximum period allowed for CMHC insured homes. Since mortgages with a down payment of 20% or less require CMHC insurance, you’ll need to put down a larger down payment (20% or more) to secure a longer amortization, such as a 30-year or 35-year period.
An amortization schedule or table details the timing of every payment you will make over the life of your mortgage. It is usually shown for every year of the amortization period. It indicates how much of each payment went to the principal loan and applied to interest.
On an amortization schedule, you will find the following:
On the schedule, you will also notice that more of each payment goes towards interest charges, while in the latter half of your amortization, more of each payment goes toward your principal. This is important because the longer your amortization period, the more interest you will pay over the life of your mortgage. The more interest you pay, the longer it takes to pay off your principal and gain equity in your home.
In short, the faster you can get to paying off your principal, the sooner you can pay off your mortgage, own your home and benefit from your home’s equity free and clear.
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A mortgage term is the length of time a mortgage contract is in effect. It can last anywhere between six months and 10 years. Usually, a shorter term means a lower interest rate, and a longer term means a higher interest rate.
During the term, you are locked into all the conditions outlined in your mortgage contract, including the fixed or variable interest rate.
At the end of the term, it’s a chance for you to renew your mortgage with your existing lender, or to find a new lender, and enter a new term contract based on the interest rates offered at that time. If rates have gone down since your previous contract, you could save money on your payments. If rates went up, however, your payments would likely increase.
Shorter-term mortgages (of five years or less) can come with fixed or variable interest rates, while longer-term mortgages are usually restricted to fixed rates. If you opt for a fixed-rate mortgage and need to break your contract before the term is over — say, because you decide to sell the property — you may have to pay substantial prepayment penalties.
You should choose your mortgage term wisely, taking into account your current financial situation, how long you expect to stay in your home, your projected financial future, as well as possible interest-rate fluctuations and changes in the economy at large.
Unless you have a very short amortization period or come into a windfall and pay down your mortgage early, you will experience the beginning and end of multiple mortgage terms over the life of your mortgage. But at the end of each term, your remaining amortization will be shorter because you have spent the intervening months or years paying down part of the principal loan.
Knowing the differences between mortgage terms and amortization periods can affect your mortgage flexibility and your borrowing costs. It’s important to strike a balance that fits your financial situation both short-term and long-term. It can be a thorny and precarious thicket to navigate, so consult your mortgage broker if you have any specific questions.
Aaron Broverman has been a personal finance journalist for over a decade. His work has appeared on such outlets as Yahoo Finance Canada, Bankrate and Creditcards.com, Money Under 30, Wealth Rocket, CBC.ca and Greedyrates.ca. This former Toronto transplant via Vancouver now lives in Waterloo with his wife and son. When he’s not writing about your money and how to use it, you’ll find his nose in a comic book relating to the work life balance of Spider-Man and the clumsy brute strength of The Hulk.