When you’re a home buyer or home seller, it’s important to know your mortgage lingo! While you don’t have to be able to calculate mortgage payments in your head, it helps to have a basic understanding of how mortgages work. Two of the most basic yet important terms to know are a mortgage term and mortgage amortization. Do you know the difference between mortgage term and mortgage amortization?
The Difference Between Mortgage Term And Mortgage Amortization
While it’s possible for your term and amortization to be the same, they’re usually different. Knowing the difference between both of them could help you save thousands of dollars of mortgage interest and enjoy your mortgage-burning party that much sooner.
Your Mortgage Term
The term on your mortgage is the time period the terms and conditions of your mortgage are guaranteed with your lender. There are two main types of mortgage rates in Canada: fixed and variable rate. With a fixed rate mortgage, your mortgage rate will remain the same throughout your mortgage term. With a variable rate mortgage, your mortgage rate can change (go up or down) when your lender raises or lowers its prime rate (although the discount off prime rate usually remains the same during the term). Mortgage terms typically vary in length from as short as six months to as long as 10 years, although the most popular among Canadians is smack dab in the middle at five years.
Most of the time, the longer the period of time your mortgage term is, the higher your mortgage rate will be. As mentioned, some lenders offer mortgage terms of 10 years, although you’ll typically pay the highest rate for a decade of interest rate certainty. The mortgage term you end up going with depends on several factors including how risk-adverse you are and how long you plan to stay in your home. For example, if you may only stay in your home for two or three years, signing up for a five-year probably doesn’t make a lot of sense. You might be better off with a two or three year fixed rate mortgage or a variable rate mortgage, where the penalties tend to be lower than those on fixed-rate mortgages of comparable terms.
Your Mortgage Amortization
While your mortgage term is the time period until your mortgage comes up for renewal, your mortgage amortization is the time period until your mortgage is fully repaid. The standard mortgage amortization is 25 years, but that doesn’t mean you can’t go with a shorter or longer amortization period (although you can go as high as 30 years with a conventional mortgage). All things considered equal, a longer mortgage amortization means your mortgage payments will be more affordable, but you’ll pay more interest over the life of your mortgage. With a shorter amortization period, your mortgage payments are higher, although you could save thousands of dollars in interest overall.
As you pay down your mortgage, your amortization period should become shorter. For example, if you started with a 25 year amortization period and choose a five-year fixed rate mortgage (presuming you don’t make any prepayments), you’ll have 20 years left on your amortization period when it comes up for renewal.
If you want to pay down your mortgage aggressively, you might choose a shorter amortization period when starting out. For example, instead of 25 years, you might go with 15 or 20 years. But just keep in mind that if something were to happen to you financially, you’re more than likely tied to these higher mortgage payments.
That’s why a better strategy if you’re financially disciplined, is to choose a 25 years amortization and take advantage of the prepayments that come with most mortgages. Usually, you can increase your regular payment, make lump sum payments and maybe even double up your payments. By using this strategy, you can make extra payments when you can afford it and pay the minimum if you run into financial difficulty.
Likewise, if you’re running into difficulty qualifying for a mortgage, you might consider stretching your mortgage amortization to 30 years (if you’re making at least a 20 percent down payment), to lower your debt ratios. By working with a good mortgage broker, they’ll do their best to help you qualify for the purchase price you’re looking for.
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About the Author
Sean Cooper is the bestselling author of the book, Burn Your Mortgage: The Simple, Powerful Path to Financial Freedom for Canadians. He bought his first house when he was only 27 in Toronto and paid off his mortgage in just 3 years by age 30.