Term vs. Amortization

August 8, 2011

Mortgage Monday

The mortgage industry has an abundance of buzz words, phrases and acronyms that can be a common source of confusion for prospective home buyers.  Hopefully as you read through this weekly “Mortgage Monday” column, I can help put these words and phrases in terms a little easier to understand.

The first couple of phrases you’ll probably hear are “term” and “amortization.”  Both phrases refer to a period of time in the life of your mortgage.  The term of a mortgage can be defined as:

The length of time you are committed to a mortgage rate, lender, and conditions set out by the lender.

The term will have a direct effect on your mortgage rate (generally, the shorter the term, the lower the rate).  And, of course, there are many instances where you can actually break the term of your mortgage (to pull equity out, to get a lower rate, etc), though there may be penalties involved (something we will discuss at a later date).  A typical mortgage term in Canada is 5-years, though they can range anywhere from 6-months to 10 years.

The amortization of a mortgage can be defined as:

The length of time it takes you to pay off your entire mortgage.

The longer the amortization period, the lower your monthly payments will be (as they’re being stretched out over a longer period of time).  That being said, the longer the amortization period is, the more interest you’ll pay over the life of the mortgage.  A typical amortization period for 1st-time home buyers in Canada is 25 or 30 years.

It comes down to this: “shorter term = smaller rate” and “shorter amortization = smaller paymentsbut “shorter amortization = more interest.”  If you can afford it, getting a shorter amortization period is preferred, as it will save you a lot of money over the life of your mortgage (you’ll have higher payments, but you’ll pay off your mortgage faster, and spend less money).  As for term, some people prefer to get a smaller rate over the short term, hoping that rates don’t go up, whereas others prefer to lock in a slightly higher rate for a longer term (which lightens the risk of the mortgage debt, as you know your interest rate will remain the same over the length of a longer period of time).

Think of it this way: the life of your entire mortgage (amortization) is broken up into a bunch of little chunks (terms).  The longer the life of your mortgage, the more you’ll pay in interest. The terms, however, are just a measure of how much risk you’re willing to endure.  The longer the term, the higher the rate, but the lower the risk (of rates jumping up).  The shorter the term, the lower the rate, but the risk of rates going up by the time your term is up increases.

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About Tim

Tim is a mortgage agent in Barrie who specializes in helping first-time home buyers. He works with a variety of lenders and can help customize a mortgage with the best rates & options that fit the needs of each customer.

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