Mortgage Amortization: Should You Go Long or Short?

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If you’re in the market for a new home you probably understand the different mortgage options. But what about amortization? Should you go short or long on your amortization, and what impact does it have on your finances?

The most common amortization is 25 years. If you have at least a 20 percent down payment, however, you can go higher—up to 30 years, and sometimes longer.

Shorter amortizations are also available. Their benefit is helping you accumulate home equity faster. If you can afford the higher monthly payments of a shorter amortization, you can save thousands in interest payments.

Why Go for a Long Mortgage Amortization?

After the 2008 recession, the Canada Mortgage and Housing Corporation (CMHC) progressively lowered the maximum amortization period on default insured mortgages. Formerly, homebuyers could amortize their mortgage over 40 years. Now, homebuyers who do not have at least 20 percent equity are limited to a maximum amortization of 25 years.

If you do have 20 percent-plus equity, you have the option of choosing a 30-year amortization. (A few lenders allow up to 35-years but the rates are much higher.)

With the low interest rates and a longer amortization, you can expect the minimum monthly payments to be a lot smaller. But the overall interest paid will be higher, and the length of time it takes to pay off will be longer.

Here’s an example to make the point. If you have a mortgage of $500,000, a rate of 2.39 percent, and a 25-year amortization, you would have a monthly payment of $2,213. The interest you would pay over this longer period of amortization would amount to $163,760.12. If you were to choose a shorter amortization of 20 years, you would see those monthly payments rise $407 to $2,620. But you would pay $34,973.83 less interest on the same mortgage amount, or a total interest of $128,786.29.

Minimize Your Risk

If you are stretching your budget to fit the mortgage payments of a short amortization, you may be in over your head. If you unexpectedly lose your job or get sick, it’s harder to make those higher payments.

A longer amortization can be seen as a form of risk management. Your monthly payments won’t be as high with a 30-year amortization as they would be with a shorter 25-year amortization, making unexpected financial woes more manageable.

This doesn’t mean you can’t pay off your mortgage quicker and save on interest payments. Most lenders allow generous prepayment privileges. This means you can usually make extra lump-sum payments once or multiple times a year. You can also accelerate your payment frequency to bi-weekly or even weekly, and pay more than the minimum monthly payment.

Amortizing over 30 years lowers your payment to something more manageable. Then you can pay the principle faster (within the limits of your mortgage contract) when you know you have the extra funds. You can always stop the prepayments in the event of a financial emergency.

In essence, with discipline you may end up saving the same amount of interest as you would on a 25-year amortization, with less risk.


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Prioritize Your Debt

Even if you’re not able to accelerate your mortgage payments, you can still benefit from a long amortization. The lower monthly payments may give you the wiggle room to focus on other debts. Since mortgage debt is one of the cheaper forms of debt, it makes sense to focus on paying off your high-interest debt, like a credit card, first.

Alternatively, you may have other financial priorities that give you a greater return than your mortgage. For example, you may want to consider putting more money into your Registered Retirement Savings Plan (RRSP), or other investments, if the return is greater than the interest on your mortgage. If your mortgage payments are taking up too much of the budget, you may not be able to manage this. A longer amortization may give you this flexibility.

Choosing a Shorter Amortization

If you are afraid to check your bank account at the end of the month and live beyond your means, you may not be disciplined enough to benefit from a long amortization. A shorter mortgage payback period may serve as forced savings and reduce the amount of disposable income spent frivolously.

On the other hand, if you consistently use spare money to contribute to your RRSP and investments, you may be able to take advantage of the interest rate differential between those savings vehicles and your mortgage.

Mortgage rates are currently at an all-time low, but they may not stay that way forever. If you lock-in with a low five-year fixed rate mortgage now, you will most likely renew at a higher rate. Your mortgage payments will be higher. But by having a shorter amortization, you can pay off your mortgage sooner, pay less total interest, and extend your amortization later (if needed) to lessen the payment impact of rising rates.

To see how much interest you can save with a shorter amortization, plug your numbers into the Mortgage Payment Calculator and adjust the amortization period.

Choosing The Right Path For You

Tools like the RateSupermarket.ca Mortgage Affordability Calculator, can help you find a starting budget by factoring in your gross household income and expenses. From here, consider your financial habits, level of discipline, and priorities.

The smaller monthly obligation associated with a longer amortization period can be useful to those who may work on commission or have inconsistent income, first-time homebuyers on a budget, and those wishing to invest their disposable income.

Related Topics

Mortgages

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