Understanding Mortgage Term and Amortization
Mortgage Term: This is the length of time you commit to a specific lender, interest rate, and mortgage conditions. Typical terms in Canada range from 1 to 5 years, with 5 years being the most common. At the end of the term, you need to renew your mortgage under new terms. If you want to sell or refinance before the term is up there is a “prepayment” penalty.
Amortization Period: This is the total time it takes to pay off your mortgage in full. The most common amortization period in Canada is 25 years, but it can extend up to 30 years for insured mortgages or be shorter for those seeking faster repayment.
Key Considerations When Choosing a Mortgage Term
- Interest Rate Trends:
- Shorter terms: **Historically had lower interest rates but require more frequent renewals. This could be advantageous if rates are expected to decline.
- Longer terms: Provide stability and protection from rate increases but may lock you into higher rates if interest rates drop during your term.
- Financial Stability:
- If your income is stable and predictable, and rates are projected to decrease in alignment, then a shorter term might allow you to take advantage of potentially lower rates at renewal.
- For those with less predictable finances or nearing retirement, a longer term can provide peace of mind with consistent payments.
- Market Conditions:
- It’s important to have some idea whether A) Fixed and B) Variable rates are expected to increase or decline in the near future and beyond. They don’t move together. Variable rates are tied to the Bank of Canada Policy Rate and Fixed Rates are tied to Canada 5 year bond yields.
Your mortgage broker watches these closely and can give you insights and refer you to information, but remember that nobody has a crystal ball.
- Renewal Risks:
- Nobody could predict Covid-19, and borrowers renewing in 2025 will mostly be facing higher interest rates compared to their rates. Conversely if rates are expected to decrease then you will welcome the opportunity to change your rate at that time. What is expected? And, can you count on that? Or, would you prefer to lock in and not worry. It’s sort of like picking the right line in a busy grocery store.
Key Considerations When Choosing an Amortization Period
- Monthly Affordability vs. Long-Term Costs:
- A longer amortization period: Reduces monthly payments but increases overall interest costs. For example, on a $300,000 mortgage at 4%, a 25-year amortization would cost $173,418 in interest compared to $135,057 over 20 years.
- A shorter amortization period: Means higher monthly payments but saves tens of thousands of dollars in interest and allows you to become mortgage-free sooner.
- Flexibility for Other Financial Goals:
- Longer amortizations: Free up cash flow for other priorities like investments, education savings, or emergency funds.
- Shorter periods: Are ideal for those prioritizing rapid equity accumulation or aiming for early retirement.
- Future Financial Needs:
- If you anticipate needing access to home equity (e.g., for renovations or education), a longer amortization may provide more manageable payments while preserving liquidity.
- Conversely, paying off your mortgage faster builds equity quicker, which can be leveraged later if needed.
Factors Influencing Your Decision
- Job Stability and Mobility:
- If you expect to a job change or to relocate in the near future, consider a term that will align, or a mortgage with flexible prepayment options to avoid penalties for breaking your mortgage early. By default a good broker will always choose a mortgage with nice flexible terms to “future proof” you.
- Future Income Growth:
- Anticipated raises or bonuses might allow you to handle higher payments associated with shorter amortizations while saving on interest costs. Paying off a car loan soon and won’t need another for a while – there’s some extra room in your budget maybe. If you know you will be needing to buy one soon – the opposite is true.
- Conversely if you’re planning to change jobs, have children or to go back to school within a few years, then a longer amortization will lower your monthly payments and more likely allow you to accumulate more savings, or even out some of those bumps.
Examples of Different Scenarios
- Scenario A: A young professional with stable income anticipates salary growth and opts for a 20-year amortization with a 3-year term at a lower rate**. This allows them to save on interest while retaining flexibility at renewal.
- Scenario B: A family with fluctuating income chooses a 30-year amortization for lower monthly payments and a 5-year fixed term for stability during uncertain economic times.
- Scenario C: An investor prioritizes liquidity and cash flow by selecting a longer amortization but plans lump-sum prepayments when possible to reduce overall costs.
Conclusion
Choosing the right mortgage term and amortization period requires balancing short-term affordability with long-term financial goals. Consider factors like market trends, personal circumstances, and future plans when making your decision. By carefully evaluating your options and seeking advice from your mortgage broker you can optimize both cost savings and financial flexibility over the life of your mortgage.
Disclaimer: This article is intended for informational purposes only and does not constitute financial advice. Always consult with a licensed mortgage professional before making decisions regarding your mortgage options.
**Currently Fixed Rate 5 Year mortgages offer the lowest rate.
