This article has been updated. Check out the new version of Mortgage Amortization: Should You Go Long or Short?
After months of searching you’ve finally bought your dream home and have been approved for a five-year fixed rate mortgage at 2.99 per cent – great! Now, it’s time for your next big financial decision – how long should your mortgage amortization be?
While the most common amortization is 25 years, some mortgages offer home buyers the option to pay more than their minimum monthly payment, shortening the length of the mortgage to 20 or even 15 years. As well, choosing a shorter amortization to begin with will see you owning your home sooner – if you can swing the higher payments. Let’s take a look at the benefits of both.
Why Go For a Long Mortgage Amortization?
Until last year homeowners could choose a maximum mortgage amortization of 30 years – but that’s no longer the case. Last year’s CMHC mortgage rules changed the maximum amortization from 30 years to 25 years for homeowners making less than a 20 per cent down payment (you can still get a 30 year amortization if you have a conventional mortgage). What does this mean for homeowners? It means you’ll have to pay a higher mortgage payment.
So why would you go with a longer amortization? Mortgage rates are at their lowest levels ever – five years ago you’d most likely be paying over five per cent for a five-year fixed rate mortgage, while today you can get a similar mortgage for less than three per cent.
Prioritize Your Debt
Mortgage debt is also one of the cheapest forms of debt. If you have high interest debt like credit card debt, it makes sense to concentrate on paying that off first (you can even consolidate your debt with your mortgage). As the saying goes you shouldn’t put all your eggs in one basket – perhaps you have other financial priorities and you’d like to continue to contribute to your RRSP while paying down your mortgage. If your mortgage rate is at 2.99 per cent and you can achieve a return of at least five per cent in your RRSP, it makes sense to contribute to your RRSP.
Minimize Your Risk
A longer amortization is also a great form of risk management. If you lose your job or get sick, your mortgage payments won’t be as high with a 25-year amortization than if you had opted for a 20-year.. Just because you go with a longer amortization doesn’t mean you can’t pay off your mortgage sooner. Most lenders have generous prepayment privileges – you can often increase your mortgage payments and make lump sum payments by 15 or 20 per cent. You can pay the same mortgage payment had you went with a 20 year amortization, but with less risk, since you can always stop the prepayments if you have a financial emergency.
Why Choose a Shorter Amortization?
You’ll only benefit from a longer amortization if you’re financially disciplined and use the extra money towards prepayments or contributing to your RRSP. If you’re afraid you’re going to spend your money on the latest high-tech gadgets, a shorter mortgage amortization makes sense. By paying off your mortgage sooner you’ll save thousands in interest and be debt-free sooner. Mortgage rates may be low now, but interest rates won’t be low forever. If you just locked-in with a five-year fixed rate mortgage, five years is a long time – if your mortgage rate is at 2.99 per cent and you renew in five years at 4.99 per cent, not only will your mortgage payments be higher, you’ll also pay more interest. For example, if you have a mortgage of $340,000 your monthly mortgage payments would be $1,881 amortized over 20 years. However, at a mortgage rate of 4.99 per cent, your monthly mortgage payments would jump by $351 to $2,232. By paying off your mortgage sooner you’ll protect yourself from rising interest rates upon renewal.
Wonder how your monthly mortgage payments will look with a lower amortization? Use our mortgage calculator to crunch the numbers.
The Decision is Yours
If you’re a first-time home buyer, a shorter amortization can put a strain on your budget – until you’ve lived in your house and know what the bills are, it can be a challenge to predict what you’ll be able to afford monthly. Tools like our mortgage affordability calculator, which factor in your gross household income and expenses can help find a starting point for your budget.
However, if paying off your mortgage quickly is a priority and you lack the financial discipline, going with a shorter amortization will save you thousands in interest and best of all, you’ll be mortgage-free a lot sooner.