Mortgage Amortization Period vs Mortgage Term: What’s the Difference?
When it’s time to get a mortgage, two things you’ll need to consider are the amortization period and term. However, many people aren’t sure what each one means, let alone the difference between them. While on the surface, amortization is simply the length of time it will take to pay off the entire mortgage, and the mortgage term represents the length of your current interest rate, it goes deeper than that.
Knowing the difference and how each one can affect your borrowing costs and your mortgage flexibility will save you a lot of money in the long run. So, if you’re unsure about mortgage amortization and mortgage term, here’s a refresher.
What Is a Mortgage Term?
The mortgage term represents the length of time that your current mortgage agreement is in effect. Most mortgage terms in Canada range between one and five years, although mortgage terms are available up to ten years. The mortgage agreement details your interest rate, including whether it’s fixed or variable, whether the mortgage is open or closed, any prepayment privileges you may have, among other things.
For years, one of Canada’s most popular mortgage terms has been the 5-year fixed-rate, closed mortgage. This means that your interest rate doesn’t change for five years, after which the term will expire, and you’ll be free to renegotiate another mortgage term with your financial institution. During the five-year term, your lender would penalize you if you decided to pay off the mortgage in full or beyond any prepayment privileges you are allowed. Hence the term, ‘closed’ mortgage.
You can also choose an open mortgage term, which usually means that the borrower has the option to make prepayments up to 100% of the mortgage amount at any point during the term, without any penalties. There may be exceptions, depending on the individual lender.
What Is an Amortization period?
The amortization period represents the length of time it will take before the mortgage is paid in full. The standard length of an amortization period is 25 years; however, borrowers can choose a shorter amortization, and in some cases, longer. If your mortgage will be CMHC-insured, the maximum amortization period is 25 years. If your mortgage is conventional (at least 20% down payment), your lender may allow you to stretch the amortization period to 30 years. You’ll pay more interest this way, but your affordability improves because your payments are stretched over a longer period of time.
A History of Mortgage Amortization Periods
As I mentioned earlier, the maximum mortgage amortization period in Canada is 25 years for insured mortgages and 30 years for conventional. This wasn’t always the case, however. Leading up to the financial crisis in 2008, the federal government loosened the mortgage rules, allowing for amortization periods of up to 40 years.
At the time, the government saw this as a move to improve housing affordability in an era of rising prices. Instead, it led to many Canadians borrowing excessive amounts of money against their home equity. As early as 2008, the government began to tighten the rules once more, and the maximum amortization period was gradually reduced.
The Benefits of a Shorter Amortization Period
If you can afford to pay a little more each month, you’ll save thousands of dollars over the years by choosing a shorter amortization period. One of the best ways to do this is to opt for a rapid-biweekly mortgage payment instead of monthly. Because there are 26 bi-weekly periods in a year, you will make two extra bi-weekly payments every year. If you are in a 25 -year amortization mortgage, this strategy alone will result in you paying the mortgage off approximately four years early while saving thousands in interest.
The Relationship Between Mortgage Terms and Interest Rates
Perhaps the first thing a person who is applying for a mortgage wants to know is what their mortgage rate will be. After all, a mortgage is the biggest loan most people will ever have, so the interest rate matters. Often, the interest rate the bank offers will depend on the mortgage term you choose.
Open vs. Closed Mortgage Rates
Generally speaking, closed mortgage rates are lower than open mortgage rates. Think of it this way. With an open mortgage, you are paying a premium for the ability to pay off and close the mortgage at any time. With a closed mortgage, you are giving the lender more certainty that the loan will be outstanding for the term so they can reward you with a better rate.
Fixed vs. Variable Mortgage Rates
When you choose a mortgage term, you’ll have the option of a fixed or variable rate mortgage. As we’ve already covered, a fixed rate does not change during the mortgage term. On the other hand, a variable rate floats up and down with the Bank of Canada Prime Rate. Sometimes the fixed rate will be lower; other times, the variable rate is the better of the two. Because of the fluctuating nature of a variable rate, it’s considered riskier than a fixed rate. Generally speaking, borrowers with less budget flexibility are better off with a fixed rate. Those willing to take some risk may find themselves ahead with a variable rate, should interest rates trend downwards during the term.
Final Thoughts on Mortgage Amortization Period and Term
Whether you stumbled upon this article while looking for an amortization definition, a mortgage term definition, or both, I trust that I’ve provided you with enough knowledge to make an informed decision when you apply for a mortgage. Of course, don’t hesitate to ask these questions of your mortgage broker or bank advisor. They have the expertise and can give you the best mortgage advice based on your situation.