In simple terms, the amortization period is essentially the length of your mortgage. Specifically, it is the period of time during which payments are made to pay off the entire value of the mortgage taken out. This depends on several factors, and the length of your amortization period is somewhat limited by the down payment you make at the beginning of the loan period. The minimum down payment is 5% of the purchase value of the property. If your down payment is less than 20%, you will be limited to a 25-year amortization period. However, if you can afford a down payment of more than 20%, you can increase your amortization period to 30 years with most lenders. In addition, if you have been able to make a down payment of more than 20%, you also do not need to obtainCMHC insurance to insure your mortgage against default. The main advantage of a longer amortization period is that the monthly payments will be lower. However, there are pros and cons to each option. A “short” amortization is generally defined as up to 25 years, and anything beyond 25 years (25-35 years) is considered a long amortization.
Advantages and disadvantages of short amortization (25 years or less)
Benefits
- Possibility of making a small down payment (as little as 5%)
- Faster mortgage payment
- You will pay less interest over the amortization period because it will be paid off faster, so there is less risk for the lender.
Disadvantages
- Your monthly payments will be higher than those of a long amortization comparative mortgage.
Advantages and disadvantages of long amortization (26-35 years)
Benefits
- Your monthly payments will be lower than a comparative short amortization mortgage. This means better cash flow that can be invested in other areas.
Disadvantages
- You will be required to make a down payment of at least 20%. This could negate the financial benefit of lower monthly payments.
- It will take longer to pay off your mortgage. This is an essential element for those who wish to own their property for the duration of the mortgage.
- You will pay more interest throughout the amortization period because of the longer term.
How to choose?
Looking at Canadians as a whole, the most popular amortization is generally up to 25 years. This is likely because it is the most accessible option due to the lower down payment requirement and the appeal of a faster mortgage payout. The distribution of owners in Canada can be broken down as follows:
- Up to 25 years old: 79
- 26-30 years old: 21%.
- 31-35 years old: 6
- 36-40 years old: 1
As you can see, it is rare for homeowners to opt for a 30-year mortgage. This is also due to the fact that in July 2012, the maximum amortization period was reduced for any CMHC insured mortgage. In short, this means that unless you could put more than 20% down on the property, you could not access longer amortization mortgages. This measure was intended to reduce the amount of debt carried by Canadian households. One of the benefits of a longer amortization mortgage is that you will save a significant amount of money each month. For example, if you compare a 25-year mortgage to a 30-year mortgage on a $300,000 loan, you will save about $155 per month (3.49% interest). If you invested that $155 per month in an ETF with an average return of 8%, you would have approximately $210,000 at the end of your amortization period. However, the additional interest you pay on the 30-year mortgage is only $33,000 more. It seems obvious that a longer period is preferable. But always keep in mind the 20%+ down payment factor, and not many people will have access to that much money to spend at once. The only person who can answer the question of what type of amortization period to choose is you. You know your personal situation better than anyone, as well as your current and future financial prospects. Talking to a financial expert can help determine exactly what type of mortgage term would be best for you.
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