When it comes to monthly bills, your mortgage payments are bound to be some of the biggest. And it's the amortization period on your mortgage that determines just how big or small these payments will be.
There are a few details about your mortgage that you'll want to negotiate with your lender, and the amortization is one of them. More specifically, the length of your amortization is a crucial factor you'll want to carefully consider before committing to a mortgage.
The question is, what's better for your particular financial situation: a short-term or long-term amortization period?
What is an "Amortization Period?"
No matter what loan amount you take out for your mortgage, your loan balance will be "amortized" over a specific number of years. Every monthly payment that you make goes towards paying off your principal portion, as well as interest.
Your mortgage amortization basically averages out all the payments you would need to make over a certain amount of time until the entire loan amount is paid back in full.
READ: Canadians Are Committed To Paying Down Their Mortgages Quickly
The "amortization period" is the total length of time that you will have to fully repay your loan. This period is typically expressed in years.
Don't confuse your amortization period with your mortgage "term," the latter of which refers to the length of time that your mortgage remains in effect. Once that time period expired, you'll have to renew your mortgage at new terms, but your amortization period will remain the same unless you choose to refinance.
The Argument For a Short-Term Amortization Period
Amortization periods that are 5, 10 or 15 years in length are considered short-term. With a shorter amortization period, the entire loan amount will need to be paid off in full in a shorter amount of time.
There are a few key reasons why some borrowers may choose a shorter amortization period over a longer one. For starters, the entire loan amount can be paid back much sooner. That means you can achieve financial freedom a lot sooner.
READ: This Common Mistake Could Mean More Mortgage Payments
Another perk associated with a shorter amortization period is lower interest rates. Generally speaking, the longer the amortization period, the higher the interest rate.
Signing up for a short-term mortgage can help you lock into a rate as much as one percentage point lower than a long-term mortgage.
By taking advantage of lower rates that often accompany short-term amortization periods, you can save a lot of money over the life of the loan, making these mortgages a lot more affordable when all is said and done. Plus, a shorter-term home involves paying a lot less in overall interest simply because it's paid off sooner.
The Argument For a Long-Term Amortization Period
In Canada, the maximum amortization period for CMHC-insured home loans (with less than a 20 per cent down payment) is 25 years. For "conventional" loans (with at least a 20 per cent down payment), the maximum is 30 years.
That means if you can come up with a minimum 20 per cent down payment on your home purchase, you may be able to qualify for a 30-year amortization period. If your down payment is less than 20 per cent of the purchase price of your home, your maximum amortization period will be 25 years.
The biggest advantage of a long-term amortization period is the lower mortgage payments. Since you have a lot more time to fully repay your loan amount, each payment amount will be lower as the entire loan amount is averaged over many more years.
READ: Real Estate Over Retirement: Funding The Canadian Dream
This is why longer amortization periods like 25 years are very popular among borrowers who may have tight budgets to stick to. Lower monthly mortgage payments over a longer time period are especially beneficial for first-time homebuyers who may have even less money to play around with.
While shorter amortization periods allow borrowers to pay off their loans faster and save a lot of money in interest over the long run, the higher monthly payments might be too much for many borrowers to manage.
Which Amortization Period is Best For You?
The thought of being able to get rid of your mortgage sooner rather than later and potentially save tens of thousands of dollars over the life of your loan sounds great. But the idea of being able to pay less every month towards your mortgage and freeing up more money in your budget for other things might sound even better.
READ: Canadians Turn To Big Banks For Mortgages Despite Higher Rates
Ultimately, the choice you make between a short-versus a long-term amortization period comes down to your specific financial situation. If you've got the finances to comfortably make higher mortgage payments, then perhaps a shorter amortization period might be a viable option, especially when you consider how much money you can save over the long run.
If money is tight and higher payments have you in a bind, a long-term amortization might be better. While it may cost you more at the end of the day, your ability to make your payments on time every month is a crucial factor to consider.
