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Terms and Amortization
01 July 2009

It's important when familiarizing yourself with your mortgage to understand the difference between your mortgage's term and its amortization.


The amortization is the entire repayment period, expressed either in years or in the number of fixed payments.. It's usually a substantial length of time, given how big mortgage loans usually are; by spreading it out over such a long time, you can pay it back little by little each month. You can decide on your amortization period at the outset; most people will opt for terms of 20-25 years, but it's possible to have shorter and longer periods. Generally, 30 years is the cap other than in exceptional cases; most lenders will want to recover their money in a 'reasonable' length of time. Shorter terms mean you will have higher monthly payments to pay it back faster.


For example, let's take a $200,000 mortgage at 5% average interest. With a 25-year amortization period, your monthly payments would be $1169.18 per month. If you chose a period of 15 years, your payments would go up to $1581.59 per month. The real benefit, however, is in how much interest you save: in the 25-year scenario, you would pay $150,000 total interest, while in the 15-year scenario you would pay just under $85,000 --- a savings of $65,000. Shorter amortization periods mean less interest, so it's to your advantage to maximize your monthly payments as much as possible.


It's worth noting, too, that in the 25-year amortization, you end up paying about ¾ of the total value of the original loan. That's a hefty amount, any way you look at it. Your mortgage broker can help you run different scenarios based on your monthly income to determine how much you can afford to pay, to reduce your costs over the long term.


Somewhat confusingly, the word 'term' can also be used to describe the total loan period, but it also can refer to the term for which your interest rate is guaranteed by your lender. For example, even on a 25-year mortgage, your lender might offer you a 5-year term on a 5% fixed interest rate. That means the rate is guaranteed to stay at 5% for the next five years, after which you will have to negotiate a new interest rate depending on the conditions at that time, or pay out the mortgage in full.


Terms can be as short as six months, or as long as ten years. The interest rates offered will vary depending on the length of the term, and what predictions lenders are making about how economic conditions will change in the near and mid-term future.


Figuring out which term to opt for can be a daunting choice, as it places the burden on the borrower to make predictions about the future too: is it best to lock in for five years at a somewhat higher rate, believing rates will only go up in the meantime? Or is it best to take advantage of lower rates for a year or two, and hope rates will stay stable, or even go lower? There are a lot of factors that go into this complex decision, including how much risk you are willing to take. Your mortgage broker will go over all the options with you carefully, and help you to make an informed decision that meets your needs and preferences.