When you apply for a mortgage you will likely here about two different time periods:
Your term is is the length of time you commit to the mortgage interest rate you signed up for. For example you might sign up for a 5 years fixed term. After five years, you renew your mortgage at a new interest rate.
Your mortgage amortization period is the number of years it takes to repay your mortgage in full. The maximum amortization period in Canada is 35 years, although the maximum period for a government-insured loan is 25 years.
A typical mortgage amortization period would be 25 years, meaning that it would take 25 years to repay your mortgage. Since your lender is charging you interest on your mortgage, the longer the amortization period the more you will pay in interest.
How long should your amortization period be? It depends on what you can afford each month and how long you want to be in debt.
To help you understand how your mortgage amortization period can influence the amount of money you save/spend, below we provide a simple example explaining the calculations involved.
Let’s say you have a $200,000 mortgage at a 6% interest rate.
With a 25 year amortization period, your monthly payment would be $1,279.61; that means that over the 25 year life of your mortgage, your total payments will be $383,883.
However, if you shorten the amortization period to 20 years, your monthly payment increases to $1,424.38; bad news, right? Not necessarily. Because you are now only paying for 20 years, instead of 25 years, you have reduced your total payments from $383,883 over 25 years to only $341,851; that’s a savings of almost $42,000.
Going a step further, if you could pay off your mortgage in 15 years, your monthly payment would be $1,679.77, but your total payments over 15 years would be only $302,359, for a saving of over $81,000!
And remember, in your payments you are paying back both principal an interest. In our example, the first $200,000 you repay is the money you borrowed when you bought your house; the rest is the interest. So, as you can see the savings are significant when you shorten the amortization period.
Use a mortgage payment calculator to calculate what your monthly payment would be under different amortization periods, down payment and interest rate options. Then armed with this information, shop around with different lenders to see who can provide you with the best rate for your given situation.
So, what amortization period is best for you?
When you first purchase a home cash is tight, so a 25 year amortization may make sense. However, if your financial situation improves by the time you need to renew your mortgage, it may make more sense to shorten your mortgage amortization period.