It can be confusing for mortgage shoppers when they get a 25 year mortgage and a 5 year term at the same time. It can seem counterintuitive to have a loan last five times as long as the term, but it’s actually very simple.
Mortgage Term
A term is an agreed upon length of time that you promise to repay your mortgage according to the interest rate and conditions set out by the lender. A term can last anywhere from 6 months to 10 years, but the most popular term is for 5 years. This is also the length of term that the Bank of Canada uses as their benchmark rate for mortgage qualification.
The mortgage term is not how long it takes to repay your mortgage in full. At the end of your mortgage term, if there is any remaining balance on your mortgage, you’ll have to get another term.
Mortgage Amortization
Mortgage amortization is the amount of time it will take to pay back your mortgage entirely. Currently in Canada, the maximum amortization period is 35 years. However, that only applies to mortgages without CMHC (mortgage default) insurance. In other words, it’s only possible to get a 35 year amortization if you purchase a home with a down payment of 20% or more. For CMHC insured mortgages, or purchases made with a down payment of less than 20%, the maximum amortization period is 25 years.
By taking advantage of prepayment options, the real amortization time can be shortened. You can also choose to shorten the amortization when it’s time to renew your mortgage term.
|
|
Amortization |
What is it? |
A length of time
that you agree to a set interest rate with one lender |
How long it will
take you to repay your mortgage in full |
How long does it last? |
6 months – 10 years |
Up to 25 years if
CMHC insured, up to 35 if not |
What does that mean? |
After the term is
ended, you will have to renew your term with your current lender, or shop
around for a better rate with other lenders |
Your
monthly payments are determined by how long you set your amortization for.
Longer amortizations mean smaller monthly payments, but higher interest costs |
Case Study: Amortization in Practice
If you’re curious to see exactly how amortization affects how much you pay, let’s do a case study using our monthly payment calculator.
Imagine buying a home with a purchase price of $300,000.
In Canada, you must have a down payment of at least 5% - but the higher the better. Higher down payments mean smaller mortgages, translating into lower costs: in CMHC premiums, interest rates, and total cost of interest. We’ll say we have a 10% down payment.
In one scenario, we’ll set the amortization for 20 years. In another, we’ll set it for 25 years to see how they’re different.
As you can see, everything except the amortization is the same. Because the length of amortization doesn’t affect the initial cost of a mortgage, the total mortgage required for both scenarios is the same.
In the first scenario, with a shorter amortization, the monthly payments are $224 higher – an annual increase of $2688. But the monthly payments don’t tell the whole story.
For a 20 year amortization, you’ll make a total of 300
payments of $1319. In total, you’ll have paid $117,214 in interest, for a total
mortgage cost of $395,584 after 20 years.
For a 25 year amortization, you’ll make 360 payments of $1172. In total, you’ll have paid $143,593 in interest, for a total mortgage cost of $421,963 after 25 years. A difference of $26,379!
|
|
25 years |
Difference |
Initial mortgage cost |
$278,370 |
$278,370 |
$0 |
Interest rate |
2.99% |
2.99% |
- |
Monthly payment |
$1316 |
$1540 |
$224 |
Total interest paid |
$117,214 |
$143,593 |
$26,379 |
Total mortgage cost |
$395,584 |
$421,963 |
$26,379 |
It’s no secret that buying a home is a major milestone that many of us work to...
There's a lot of talk going on today about refinancing and consolidating. Howeve...
Congratulations on your first mortgage! It's a big accomplishment, and it should...
The most valuable asset many Canadians have is their house, and a Home Equity Li...