Mortgage terms and amortization
What are mortgage terms and amortization
When you shop around for a mortgage, you need to decide on the mortgage term and amortization period.
The term and amortization impact:
- your overall costs
- your interest rates
- your regular payment amounts
The mortgage term is the length of time your mortgage contract is in effect. This includes everything your mortgage contract outlines, including the interest rate. Terms can range from just a few months to five years or longer.
At the end of each term, you must renew your mortgage. You’ll likely require multiple terms to repay your mortgage in full. If you pay your mortgage balance at the end of your term, you don’t need to renew your mortgage.
The amortization period is the length of time it takes to pay off a mortgage in full. The amortization is an estimate based on the interest rate for your current term.
If your down payment is less than 20% of the price of your home, the longest amortization you’re allowed is 25 years.
Figure1: Example of a mortgage of $300,000 with a term of 5 years and amortization of 25 years
Text version: Figure 1
Visual representation of a mortgage of $300,000 with a term of 5 years and an amortization of 25 years. The mortgage amount decreases from year 1 to year 25 as payments are made. Years 1 through 5 represent the term. Years 1 to 25 represent the amortization.
Types of mortgage terms
Mortgage terms can range from a few months to 5 years or more. The length of your mortgage term impacts your interest rate.
Most mortgage holders in Canada have a mortgage term of 5 years or less, also known as a shorter-term mortgage. The shorter the term, the sooner you renew your mortgage contract.
With a shorter-term mortgage term, you may:
- opt for a fixed or a variable interest rate
- take advantage of a lower interest rate when you sign up
Longer-term mortgages are mortgages with a term greater than 5 years. The lengthier the term, the longer you keep the conditions of your current mortgage contract.
With a longer-term mortgage, you may:
- be restricted to a fixed interest rate
- lock-in an interest rate for a longer period of time
- pay a substantial prepayment penalty if you sell your home within the first 5 years of your term
Convertible term mortgage
A convertible term mortgage means that some shorter-term mortgages can be extended to a longer term. Once the mortgage is converted or extended, the interest rate changes. Typically, the new interest rate will be the one offered by the lender for the longer term.
How your mortgage term affects your costs
Your mortgage term sets the interest rate and the type of interest for a set period. Your mortgage can have a fixed or a variable interest rate. A fixed interest rate stays the same through the duration of your term. A variable interest rate can change during your term.
Lenders normally offer different interest rates for different mortgage term lengths. The interest rates offered by lenders typically increase as the term length increases. It is not always the case. Your interest rate has an impact on your mortgage payments. Your payments are higher if your interest rate is higher.
Figure 2: Example of monthly mortgage payments for a mortgage of $300,000 with an amortization of 25 years at various interest rates
Text version: Figure 2
|Interest rate||Monthly payment amount||Interest cost over 5 years||Interest cost over 25 years|
Shop around to get the best interest rate for your mortgage term. Talk to your lender or mortgage broker to see if you can negotiate a lower interest rate.
Learn more about interest on a mortgage.
If you renegotiate your mortgage contract or pay your mortgage in full before the end of the term, you may have to pay a prepayment penalty. The amount you pay depends on the type of mortgage you have. It also depends on the conditions of your mortgage contract. This amount could be thousands of dollars.
When choosing the length of your term, consider your life situation. If you plan on moving in the near future, a shorter term may be better for you.
Learn more about mortgage prepayment penalties.
How your amortization period affects your costs
The longer your amortization period, the lower your payments will be. Keep in mind that when you take longer to pay off your mortgage, you pay more in interest.
Figure 3: Example of the effects of amortization on the monthly payment amount based on a $300,000 mortgage with a 4% interest rate
Text version: Figure 3
Figure 4: Example of the effects of amortization on the total cost of interest based on a $300,000 mortgage with a 4% interest rate
Text version: Figure 4
|Amortization||Total cost of interest|
What is negative amortization
Negative amortization can happen when you have a variable interest rate mortgage with a fixed payment. If the interest rates increase significantly, you may end up not paying enough to cover interests and principal on your payments. The interests will build up and your principal will go up instead of decreasing.
This means that even if you make your usual payments, the interests will get added to the amount you borrowed. If you don't make arrangements, you could even owe more money than the value of your home.
If you foresee challenges in covering interest and principal on your mortgage, contact your financial institution to discuss your options.
Things to consider when selecting your mortgage term and amortization
When you renew your mortgage, your lender may offer lower or higher interest rates than your current interest rate. This may have an impact on your mortgage payment amount and your budget. If your new interest rate is lower, you save money. If the new interest rate is higher, you may no longer be able to afford your mortgage payments.
Weigh your options carefully to select the best mortgage term to suit your needs.
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