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How long should my amortization period be?

by Corben Grant on 22 Jun 2022

 

Your amortization period is only one of many choices you will need to determine before you can take out a mortgage, but it’s still an important one. Like any choice related to your mortgage, it is essential that you understand what this decision means so you can make the right choice for your needs.

Amortization periods can be one of the most intimidating parts of getting a mortgage due to how long they can last. Many fear that if they make the wrong choice, they will be stuck with it for decades.

This is a reasonable way to feel, but it isn't as complicated as it seems. In addition, your amortization period may not be as set in stone as you may think.

In this article, we will explore what the amortization period means for your mortgage to help you better decide which length is right for you.

What is an amortization period?

The amortization period for a mortgage is the number of years you have to pay back your mortgage loan. Each mortgage has a term length, usually from about 1 to 5 years, during which the mortgage contract is valid. At the end of each contract, your mortgage will need to be renewed. Each mortgage will usually be renewed for multiple shorter terms over a longer amortization period.
 

Why are mortgages amortized?

Homes are expensive, and saving up for your first home would take a long time if you couldn't get a loan. Luckily, you can get a mortgage now and spread out that 'saving' for a number of years as amortization. 

But, your bank needs you to pay back the money eventually. They need an official timeline for how long they can expect it to take. Amortization is the key to determining how much interest they can make from your mortgage and how much your monthly payment will cost. This is also known as your amortization schedule, which tracks the exact state of your repayment at any given point in time. Various online mortgage calculators can provide you with an amortization schedule for your mortgage.


But why is the mortgage amortization period so much longer than the term length? The reality is that things can change between now and the end of your amortization period, and banks know this. It is incredibly difficult to predict markets over a long time horizon, and so it is in the best interest of borrowers and lenders to be able to readjust their terms every few years. An amortized mortgage is broken into terms and gives you more flexibility than being locked in for decades.

How does amortization affect my mortgage?

The amortization period you opt for will significantly affect how you pay back your mortgage.

The most obvious factor is that you will be paying for a longer or shorter period, but this length also affects the value of your mortgage payments. Assuming you secure two equally valued loans, a shorter amortization period would require larger regular payments to repay the loan in time. A loan with a longer amortization period will make a lower monthly payment over a longer period.

While a longer amortization period means lower payments, that does not mean it is cheaper. Keep in mind that the longer you pay your mortgage down, the longer you pay interest on your loan. With a longer amortization period, you trade lower payments now for a higher overall cost of your mortgage over time.

Note that while you pay more interest over time, your amortization period will not affect your actual interest rate. Usually, your interest rate is determined by your mortgage term length and will be re-evaluated at the start of each new term.

Amortization and variable rates

There are two approaches to dealing with amortization for a variable rate mortgage. One approach is to set a fixed value for a monthly payment of principal, which is paid along with a variable monthly interest charge. In this case, your amortization period will be set like any other mortgage.

Another approach is fixed monthly payments, where the ratio between principal and interest paid shifts along with interest rates. As interest rates rise, more of your mortgage payment goes towards interest. Naturally, this means you are also paying off your mortgage slower. In this case, your amortization period will be more like an approximation that is adjusted based on current interest rates.

What is the average amortization period?

In Canada, the standard amortization period is 25 years. This is in part just a matter of convention, but it also has deeper reasons for being so common.

For one, it presents a happy medium for both borrowers and lenders, where borrowers aren't stressed about paying back a mortgage in a short period with high payments, but they aren't locked in for their whole lives.

This term length also just makes sense for people's lives. Consider a couple who buys their home to raise a family. It just so happens that 25 years is enough time to raise kids and see them off as adults, in time for you to pay off your home and consider downsizing into retirement.

What is the shortest amortization period I can get?

The shortest available amortization period will be about 5 years, though this is a rare choice for Canadian borrowers. This will be most viable if you only take a minimal mortgage or can easily cover the higher payments thanks to a high income.
 

What is the longest amortization period I can get?

In Canada, the longest amortization period available is 35 years. While these mortgages make for low payments, they will also take a long time to pay. In fact, most lenders will rarely offer these mortgages, as they prefer to work with borrowers who can pay faster. These mortgages are more common with alternative lenders and may be an option for those with too low of an income to make a shorter period realistic.
 

Longest amortization for insured mortgages

There is another caveat to longer mortgages: If you are paying less than 20% for a down payment on your home, you will need to take out mortgage insurance. As part of the rules around mortgage insurance, all insured mortgages are capped at 25 years, meaning you will not be able to go any higher without putting more money down or looking for a home with a lower purchase price.

Can I get a 40-year mortgage?

Previously Canadian mortgages could be amortized for up to 40 years. This option was discontinued about ten years ago and is no longer available. The only way this mortgage may still be available is with the less regulated private lenders, though there is no guarantee that anyone would agree to such a mortgage.

Which is right for me?

The biggest factor in deciding the right amortization period for you is your income and how much you want to pay monthly. Purely looking at the numbers, shorter mortgages will be more beneficial in the long term, but not everyone can budget for high payments.

Consider how much you can pay per month based on your income and spending habits when determining your amortization period. In general, the 25-year mortgage is popular for a reason. Unless you want to minimize your monthly costs or pay off your mortgage quickly, a 20-25 year period represents a good medium.


Can I modify my amortization period?

If you feel like you made a mistake in choosing your amortization period, or your financial conditions have changed, and you want to modify your period, some options are available.

For one, if you want to shorten your mortgage, you may have the option for a certain amount of early repayment, which can help you pay off sooner. You can also pay off as much as you want if you are willing to cover a potentially hefty early repayment fee.

You also have the choice to pay off your mortgage in full at the end of a term rather than renew. This won't be realistic at the start of your mortgage, but it may be more doable later on.

Finally, you also have the option to refinance your mortgage. When you refinance, you essentially break your existing mortgage contract and start an entirely new one. Refinancing allows you to shorten, lengthen, or restart your amortization period.

Conclusion

Your amortization period is an important decision that will affect how long you have to pay back your mortgage and your monthly payment amount. With lengths ranging from 5 to 35 years, deciding on the best amortization period will come down to personal financial capabilities and preferences. If you are still unsure, consider talking to a mortgage broker who can help determine what is best for you.
 

 



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