This piece was originally published on November 18, 2019, and was updated on October 11, 2022.
Whether you're a first-time homebuyer or an experienced mortgage shopper, when it comes time to finding the best mortgage rate, you’ll have to make important decisions about the term and amortization of your mortgage. These two mortgage features have a huge impact on how much your monthly payments will be and how much interest you’ll pay. But if you’re a first-time homebuyer or this is your first mortgage renewal, you might not know what they even mean.
Let’s look at what the term and amortization of a mortgage are, and how they affect the biggest personal investment you’ll make in your life.
What is a mortgage amortization period?
The amortization period of a mortgage is the length of time over which the mortgage will be paid back.
In Canada, it’s most common for first-time homebuyers to choose a 25-year or 30-year amortization period to pay back their mortgage, but shorter options are available. For example, if you could afford the higher monthly payments you could take on a 20-year, 10-year or even 5-year amortization period. You can use our amortization calculator to generate an amortization schedule for different scenarios to see what might work for you.
What is a mortgage term?
The term of a mortgage is the length of time you and your lender commit to staying with each other.
During the mortgage term certain rules apply. The mortgage rate will remain the same (or, in the case of a variable rate mortgage, change in direct relationship with the lender’s prime rate). You’ll have limitations in how much you can increase your monthly payment or make additional payments to your mortgage (also known as prepayments). And you’ll have to pay a penalty if you choose to cancel the mortgage before the term is up.
When the mortgage term expires, all the rules come up for negotiation again. At that time you can choose to renew with your current lender, move to a new lender, or pay the mortgage off in full with cash.
Note that in Canada, mortgage terms of 1-5 years are most common. Though a term can last anywhere from 6 months to 25 years in Canada, it’s typically not advantageous to choose a mortgage term longer than 5 years or shorter than 1 year. Most Canadians select a term lasting 4 or 5 years, for the convenience and security of knowing how much one's payments will be.
What is the difference between mortgage term and amortization period?
If a friend has just decided on a 5-year variable rate for a mortgage that will take them 25 years to pay off, the 5-year period refers to the term, and the 25-year period refers to the amortization of their mortgage.
Note that these numbers don’t have a special relationship with each other. You can take on a mortgage with a 1-year term and a 30-year amortization, or a 4-year term with a 10-year amortization.
When you agree to a mortgage, neither the term nor amortization period can be changed without refinancing.
How do mortgage term and amortization period affect my payments?
Different lengths of mortgage term come with different mortgage rates. Choosing a shorter term usually (but not always) means you’ll get a lower interest rate. A longer term is usually correlated with a higher interest rate. However, most people agree that it’s worth paying a slightly higher mortgage rate and locking it in for a 5-year term rather than taking a 1-year term with a lower rate and risk your rate going up at renewal time. There can be quite a bit of paperwork on each renewal, too.
That said, rapid mortgage rate rises have narrowed the gap between 1-year and 5-year mortgages in recent years. As I write this, the best mortgage rate in Canada for a 1-year term is actually slightly higher than the best rate for a 5-year term due to an increase in demand for shorter term, fixed-rate mortgages.
Your amortization period determines how long it will take to repay the loan. Therefore, a shorter amortization period is associated with higher monthly payments and a longer amortization period is associated with lower monthly payments. However, a longer amortization also means you’ll end up paying off less of your mortgage over the term and you’ll pay more interest in the long run.
For example, if you take a $400,000 mortgage with a fixed rate of 2.49%, you’ll pay off $61,516 in principal over the course of a 5-year term when amortized over 25 years. But, let’s say you choose a 30-year amortization, that means you’ll only pay off $47,854 in principal and far more in interest. You can use Ratehub.ca's amortization calculator to see how much you'll pay with different amortization periods.
What should I consider when choosing a mortgage term?
Because your term is the period of time for which your mortgage is locked in, your primary consideration should be how soon you think you might sell your home. You could incur heavy penalties if you sell before your term is up, so don’t take on a 5-year term today if you think you’ll sell your home next summer.
You might also want to take on a shorter mortgage term if you think there’s a chance you’ll want to refinance in the near future (for example to use your home equity to pay for renovations).
Or, if you believe mortgage rates will drop significantly, you may not want to commit to a longer term at a higher rate. Taking on short mortgage terms was a common tactic during the interest rate crisis of the 1980s when mortgage rates as high as 20% were common, and has become increasingly popular in 2022 as mortgage rates continue to climb from their pandemic lows.
What should I consider when choosing a mortgage amortization period?
The mortgage amortization is a balance of your long-term expenses, monthly cash flow, and overall affordability.
For example, if you’re buying a home at the upper end of what you can afford, a longer amortization period might help you qualify for the mortgage. And the lower monthly payments might make the purchase easier.
This tactic can also improve your odds of being approved for additional credit in the future. For example, lower monthly payments can make it easier to qualify later on for a home equity line of credit (HELOC) or a car loan.
Conversely, if you’re buying a home that’s well within your budget, taking a shorter amortization period and accelerating your payments will save you thousands of dollars in interest and have you mortgage-free years sooner.
How can a mortgage calculator help me decide?
The mortgage term and amortization period directly affect how much mortgage you can afford. Using a mortgage affordability calculator can help you see how different terms and amortizations will affect your maximum purchase price.
Let’s assume you live in Ontario, earn $75,000 per year, have $100,000 saved for a down payment and have no other debts.
According to Ratehub’s mortgage affordability calculator, you can afford a home up to $459,389 with a 5-year fixed mortgage rate of 2.49% amortized over 30-years. Drop the amortization period to 25 years, and you can afford just $434,941 but you’ll also save just over $3,500 in interest.
Choosing a 20-year amortization lowers maximum affordability to but saves an additional $4,667 in interest. If you want to focus specifically on how different amortization period lengths would affect your monthly payments, our amortization calculator will generate amortization schedules for you under different scenarios.
The bottom line
Your best support in navigating mortgages is a mortgage broker. A mortgage broker can talk to you about your financial situation and shop for mortgages on your behalf. A good mortgage broker will present you with a few options, help you understand the differences and benefits of each, and give you all the information you need to make an informed decision.
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