The length of your mortgage amortization is directly related to the size of the payments you’ll be making each month. A longer amortization period will lead to lower monthly payments, however it’ll also lead to you paying more in interest over the length of your loan, as you borrow money for a longer period. With large increases in the cost of living in recent years, more Canadians have been opting for longer amortization periods in order to afford their mortgage.
Some have theorized that this might be bad news for homeowners, but let’s take a look at why a longer amortization period might be necessary, and isn’t always a bad thing.
Before we begin, make sure you’re up to date on the differences between an amortization period and a mortgage term.
Recommended reading: What’s the best mortgage term?
What is a mortgage amortization?
Your mortgage amortization is the length of time in which you’re expected to pay off your mortgage completely. When you get a mortgage, the time in which you pay it off, along with the size and interest rate of the loan, determine how large your monthly mortgage payments are. Your mortgage lender will offer you a mortgage term, typically around 5 years, at which point the conditions of your mortgage will be renegotiated, which is your mortgage renewal.
Can I change my mortgage amortization?
Your amortization period can change every time you renew your mortgage, as well as when your interest rate changes with a variable rate mortgage. With a variable rate mortgage, when interest rates change, instead of your monthly payment changing, your amortization period fluctuates up or down depending on which direction interest rates went. If interest rates go up but you pay the same monthly payment, it will take longer to pay off the mortgage as more of your payment goes toward interest and less towards the principal.
Recommended reading: Variable rate vs adjustable rate mortgages
What is the most common mortgage amortization?
The most common mortgage amortization period has historically been 25 years, and mortgage lenders prefer amortizations of 25 years or less. With that being said it’s become increasingly common for borrowers to take on 30 year and higher amortizations in order to help them afford the monthly mortgage payments.
It’s important to note that most lenders will only approve an amortization of over 25 years with at least a 20% down payment.
Why a longer amortization period can be a good thing
Our CEO Alex Leduc commented on the recent increase in mortgages with longer amortization periods and the controversy that has arised saying: “The irony is that this is being interpreted by many as lenders taking advantage of borrowers, when in fact it’s a benefit to the borrower. If a client wants to reduce their amortization back down to 25 years, they can call their lender at any time and increase their mortgage payment to. However, many people don’t have the capacity for a large increase in payments and would rather avoid doing so. Especially with rates being forecasted to fall in the coming years, the remaining amortization will go down on its own.”
For many aspiring homeowners, the choice between a longer amortization period and not being able to afford a mortgage is an easy choice to make.
It’s worth noting that regardless of rate movements, the portion of mortgages with amortizations above 30 years will be a temporary phenomenon since amortizations recalibrate at renewal (in most cases).
Another reason you might prefer a longer amortization is that as inflation devalues the dollar over time, your mortgage becomes smaller in real terms. A $500,000 mortgage today, might be “worth” significantly less in 30 years, especially considering the price of your property is likely to appreciate over that time frame. What this means is that over time your mortgage payments become easier to pay while your financial situation is likely to improve as well. While you might initially take on a 30 year amortization to afford your home, in the future you might be able to pay this off a lot faster, and can reduce your amortization period when your mortgage comes up for renewal.
So what does this mean for you?
If you’re coming up for renewal and have a variable rate mortgage, you need to assess if the new payment at renewal fits your budget before your renewal date. There are several options available to help reduce the payment further, but ultimately if the only solution is to sell, you’ll want to have enough time to prepare for that because it takes more than just a few months.
If you are considering getting a variable rate mortgage (or renewing one), you should take a look at whether an adjustable rate mortgage might be preferable. An adjustable rate also reacts to movements in prime rates, but the key difference is that payments change to keep your amortization in line. Since our analysts are now expecting to be in a declining rate environment, you’d have the benefit of seeing your payments decrease over the next few years with an adjustable rate, but not with a variable rate.
What kind of mortgage you end up deciding on will depend on your own financial situation and homeownership goals. Sign-up to Perch today and start shopping offers from our mortgage lenders.