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Mortgage Term vs. Amortization

Jamie David

One of the most common sources of confusion for prospective home buyers is the difference between a mortgage term and amortization period. Here is a short answer: A mortgage term is the length of your current contract, at the end of which you'll need to renew; The amortization period is the total life of your mortgage. A typical mortgage in Canada has a 5-year term with a 25-year amortization period.

Mortgage termMortgage amortization
DescriptionThe length of time you are committed to a mortgage rate, lender, and conditions set out by the lender.The length of time if takes you to pay off your entire mortgage.
Time frame6 months - 10 yearsCMHC-insured mortgage: Maximum 25 years
Non CMHC-insured mortgage: 35-40 years (lender-dependent)

 

Mortgage term

The mortgage term is the length of time you commit to the mortgage rate, lender, and associated mortgage terms and conditions. The term you choose will have a direct effect on your mortgage rate, with short-term rates having historically proven to be lower than long-term mortgage rates. The term acts like a 'reset' button on a mortgage. When the term is up, you must renew your mortgage on the remaining principal at a new rate available at the end of the term.

 

Historical 5-year fixed mortgage rates From 1973 - Today

 

Mortgage amortization period

The mortgage amortization period, on the other hand, is the length of time it will take you to pay off your entire mortgage. Over the course of your amortization period, you'll sign multiple mortgage contracts. Most maximum amortization periods in Canada are 25 years. Longer amortization periods reduce your monthly payments, as you are paying your mortgage off over a greater number of years. However, you will pay more interest over the life of the mortgage.

 

Maximum amortization period

As of March 2020, the maximum amortization period on all CMHC-insured homes is 25 years. This became low in June 2012, when the federal government announced the maximum amortization period on CMHC-insured homes would be reduced from 30 to 25 years. CMHC insurance is required on all home purchases with a down payment of 20% or less. Therefore, if you are putting more than 20% down on your purchase, some lenders may accept an amortization period of greater than 30 years.

Prior to this, on March 18th 2011, the maximum amortization on CMHC-insured mortgages was reduced from 35 to 30 years.

 

Short vs. long term amortization periods

Many home buyers choose shorter amortization periods resulting in higher monthly payments if they can afford to do so, knowing that it promotes positive saving behaviour and reduces the total interest payable. For example, let us consider a $300,000 mortgage, and compare a 25-year versus 30-year amortization period.

Scenario A
Shorter amortization
(25 years)
Scenario B
Longer amortization
(30 years)
Difference
(Scenario B-A)
Mortgage amount$300,000$300,000-
Amortization period25 years30 years-
Interest rate5.1%5.1%-
Monthly payment$1,762$1,620($142)
Total interest$228,580$339,659$111,079

The mortgage payments under scenario B are smaller each month, but the homeowner will make monthly payments for 5 additional years. The total interest saved by going with a shorter amortization period exceeds $100,000.

For the savvy investor, these savings should be compared to the opportunity cost of other investments. Using the example above, the monthly savings of $142 under scenario B, could be invested elsewhere, and, depending on the rate of return, could come out ahead after 35 years.

Pre-payment privileges set out by your lender will determine whether you can shorten your amortization period, by either increasing your regular monthly payments and/or putting lump sum payments towards the principal, without penalty. However, beyond these privileges, you will often incur costly penalties for making additional payments. 

 

Mortgage term popularity data

A 5-year mortgage term is the most popular duration. It sits right in the middle of available mortgage term lengths, between one and 10 years, and, thus, its popularity reflects a risk-neutral average. It also tends to be heavily promoted by major lenders. A further breakdown of mortgage terms shows that about 80% of mortgages have terms of five years or less.

 

Amortization popularity data

Below are the most recent data on amortization periods of Canadian mortgages.

Year range2
2010 - 20142015 - 2019
Up to 24 years36%30%
25 years49%58%
26-30 years12%12%
More than 30 years3%0%

The changes to maximum amortization periods have reduced the number of mortgages amortized over 30+ years. Despite that, the average amortization lengths have been increasing, with 58% of mortgages having amortization periods of 25 years. The average amortization period between 2015 and 2019 was 22 years, up from 21.4 years between 2010 and 2014, and up from 20.7 years before 1990.

 

References and Notes

  1. Source: Canadian Association of Accredited Mortgage Professionals (CAAMP) Fall 2010 Consumer Report
  2. Source: Canadian Association of Accredited Mortgage Professionals (CAAMP) Annual State of the Residential Mortgage Market in Canada 2019

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