Amortization and How It Affects Your Mortgage

As a new home buyer (or if you’re new to Canada), the various terms related to a mortgage can be confusing. This week we explore amortization and how it affects what your mortgage really costs.

To begin, the length of your amortization period is the number of years you will need to pay the full balance of your mortgage. It’s an important decision because it affects how much interest you pay over the life of your mortgage.

Historically, the banking industry’s standard amortization period has been 25 years, a standard which still applies today to government insuredmortgages. However it isn’t final… Let's explore this further!

Why choose a shorter amortization period?

• Mortgage free sooner
• Pay less interest over the life of your mortgage – saves you money
• Build home equity sooner
• Equity is the difference between any outstanding mortgage on your home and its market value. It represents the amount of money you can claim as your asset. If you choose, your equity can be used to secure lower interest cost financing for things such as home renovations, your children’s education or a second property investment.

But don’t forget…

• Your regular payments will be higher (because you’re reducing the actual number of mortgage payments)
• If your income is irregular, or if you’re buying a home for the first time and therefore carrying a large mortgage, a shorter amortization period that increases your regular payment amount and ties up your cash flow may not be the best option.

If you are comfortable with the higher payments and are looking to save money on your mortgage, then you should consider a shorter amortization period.

Why choose a longer amortization period?

• Smaller regular payment amounts
• A longer amortization period reduces the amount of your regular principal and interest payments by spreading out your payments over a longer period of time. This means you could qualify for a higher mortgage amount than anticipated. Essentially, you’re paying back less each month than if you were on a shorter amortization plan. But over the length of your mortgage you will pay more interest.
• Get into your dream home sooner – when you apply for a mortgage, lenders calculate the maximum regular payment you can afford. A longer amortization period means smaller regular payments over a longer period of time which means you could be in your new home sooner than you think!

But don’t forget…

• While a longer amortization period will appeal to some people because the regular mortgage payments can be comparable or even lower than paying rent, don’t forget that it does mean more interest will be paid over the life of the mortgage.

Regardless of which amortization period you select when you originally apply for your mortgage, it doesn’t mean you have to stay with this option for the entire life of your mortgage. Speak to your lender about your options and flexible payment plans.

Thanks to Darren Hartel at RBC bank for his help with this blog!