While low rates are important, it’s not the only thing you should consider when getting a mortgage. The term, amortization, and features are just as relevant. What you get in the end can greatly affect your payments which is why you need to know the difference between mortgage amortization and term.

What is mortgage amortization?

The mortgage amortization is the length it will take you to pay back your loan. Think of it as the life of your mortgage. Many people these days choose a 25-year amortization period to start since it offers lower monthly payments. Loans with a longer amortization period cost you more in interest. If you choose to amortize your mortgage for fewer years, you end up paying more every month, but your debt will be cleared much faster and you will end up paying less interest.

To qualify for a mortgage you need to have at least 5% saved of the purchase price as your down payment. Some lenders have been willing to loan that 5% to potential homeowners, but you need to ask yourself seriously: if you can’t even save that small amount, do you honestly think you’re ready for homeownership?

If you have a 20% down payment, then you qualify a 30-year mortgage, but again that longer amortization means more interest payments so it doesn’t exactly benefit you. What’s the point of saving 20% and then paying a ton of interest charges over 30 years? If your down payment is less than 20%, the maximum amortization you can get is 25 years.

If you can afford it, a shorter amortization period will help you save more money in the long run. I suggest playing around with any of the free amortization calculators you can find online to see the total amount of how much interest you can save by having a shorter amortization period.

What is mortgage term?

Mortgage term refers to the length of time you agree to pay back your amortized loan. It’s sort of like a short-term contract you set with your lender, so your amortization might be 25 years, but the period of the term could be anywhere between 1-7 years. Then, at the end of the loan term, you need to renegotiate to get a loan for the remaining balance on your home. 

When interest rates are low, many people choose to go with 5-year fixed terms. Shorter terms are available at an even lower rate but you’re only guaranteed that rate for that set period of time. Taking a longer-term will guarantee your rates don’t go up assuming you took a fixed rate mortgage. Variable rate mortgages are appealing to people who think interest rates won’t go up much over the current term of their mortgage. 

What many people fail to understand is that once the end of the term is up, you need to negotiate a new loan from your lender. Those low interest rates you’ve been enjoying might be higher in 5 years, so I hope you’ve budgeted accordingly. Some people are so desperate to become homeowners that they forget about the long-term costs and don’t realize that depending on interest rates, in a few years they may actually have higher monthly payments. That said, if you get in early, there’s always the possibility that your home’s equity would have gone up. That alone can be worth it for some people.

Understanding your mortgage amortization schedule

As said above, the longer the amortization period, the higher amount of interest you will pay over time. It’s also worth noting that in the beginning, the largest portion of your loan payments will go towards paying the interest on your home loan. Over time, that flips to the majority of your loan payments will be going towards the principal. Your lender can provide you with a mortgage amortization schedule, also known as an amortization table, to break this down so you can see exactly how your monthly mortgage payments are broken down. This is handy for people that want to see their principal balance and loan balance at any given time. 

The case for a longer amortization

When interest payments are low, many people are in no rush to pay down their mortgages choosing to invest instead. For example, if you’re mortgage rate is 2%, but you estimate you can get an average rate of return of 5% while investing (not factoring in taxes), you’d come out ahead.

This is certainly a good strategy if you’re a disciplined investor, but many people have maxed themselves out so they don’t exactly have any extra income to invest. There’s also the peace of mind you would get from paying down your mortgage.

Taking a longer amortization even if you can afford a shorter one can also be beneficial for cash flow purposes. Let’s say you have a $500,000 mortgage at 2%, with an amortization period of 25 years. Your monthly mortgage payment would be $2,117.26. But if you had it set for 20 years, it would be $2,527.46. A difference of $410.20 a month.

What you could do is take the 25-year mortgage, but set your payments for the 20-year term (assuming your mortgage allows you to make extra payments or lump sum payments). If you ever run into financial difficulty, you could just change your payment schedule. In this case, you can change your monthly payments back to 25 years without a penalty. A longer amortization period would also help you with the mortgage stress test since your regular payments would be lower.

Where to get the lowest mortgage rates

If you’re new to mortgage loans, it’s worth mentioning that the rates posted with the big banks are rarely the lowest rates you can get. In most cases, as a borrower, you want to work with a mortgage broker who is not associated with one single bank. Don’t worry about additional costs either. If you are a qualified borrower, there will be no fee charged by the mortgage broker as they get a commission from the lender.

Generally speaking, mortgage brokers get the lowest rates since they typically work with 30+ lenders. They can go your needs, get your information, and provide you with a quote in less than 5 minutes. 

This would just be a pre-approval, so you don’t need to commit right away. You can still shop around as you please.

Final thoughts

Now that you know the difference between mortgage amortization and term, you can think about the big picture. Homeownership is not something you should get into just because rates are low. It may seem affordable on a monthly basis, but have you considered all the extra costs? These include things like property taxes, home upgrades, and repairs. Not to mention other costs of life, such as having kids and saving for retirement. 

Lenders don’t care about how you’ll be afford anything else, they just care about you making monthly payments, and they’re more than happy to lend you a higher loan amount than you can realistically afford. As a potential home buyer, you need to take the time to learn about all the costs associated with owning a home, so you’re well informed when you’re ready to make the purchase.

Some mortgage mistakes are unintentional and totally understandable, but there are a few “mistakes” that people make that can be absolutely shocking. The sad thing is, I’m not even sure if shocking is the right word anymore. Owning a home has become such a priority for Canadians that some people are willing to do just about anything to say they own. If you plan on applying for a mortgage, try to avoid the following mistakes.

Don’t invest your down payment

When I was saving for my down payment, I really struggled with what to do with my money. I hated seeing all my hard earned cash sitting in a savings account that was making less than 2%. Surely my hard earned cash could get a better return somewhere else right? Well, of course, there are plenty of investments that might give you a better return but is that what you really want?

Getting a higher return means increased risk. So you could potentially earn a 20% return when investing your down payment in the stock market but you have just as much of a chance losing 20%. Is this worth the risk? For most people, the answer is no. If you’re comfortable with the risks involved then by all means, invest it, but I think most people are a bit more conservative.

Just so we’re clear. There are no investments that guarantee 5%+ returns without any risks.

Don’t lie on your application

Just don’t do it. I shouldn’t have to explain why lying on your application is one of the biggest mortgage mistakes to avoid but enough people do it so it deserves a mention. Some people lie about their income so they’ll qualify for a larger mortgage. Why do need to borrow more money? Because they won’t be able to afford a home otherwise. If you need to lie, the odds are you can’t afford to be a homeowner. Most lenders will do their due diligence but unfortunately, there are some questionable tactics that still happen in the industry.

Don’t apply for multiple credit cards

Whenever you apply for a credit card, your credit score takes a small hit since the application requires a hard check. This normally isn’t a big deal, but if you’re about to apply for a mortgage and you’ve recently applied for multiple credit cards, lenders may seriously question why you’ve requested so much credit. If you’re anticipating purchasing a home in the near future (less than 6 months), avoid applying for too many new credit cards.

Don’t assume you can afford it

Remember earlier how I said not getting pre-approved is a huge mistake? Well, some people still go house hunting without know how much they’ll be approved for. It’s silly to just assume that you’ll be able to afford any home you look at. You can use online calculators to get a rough idea what you’ll qualify for but speaking to a mortgage broker and getting formally pre-approved should be done before you go house hunting.

Don’t forget about your other costs

This isn’t actually a mortgage mistake but it would be pretty foolish to not consider all the costs involved when buying a home. There’s your mortgage, property tax, utilities, maintenance fees and insurance to consider but how about furniture, saving for retirement, vacations, and the costs of having kids? Don’t underestimate your costs moving forward. You want to make sure you’ve left some extra money available for those expenses that will eventually come up.

Okay, I suppose it’s possible that homeowners are taking advantage of the low interest rates and we’re investing their extra money instead of paying off our mortgages but if you recall we’re terrible investors so what exactly are we doing with our money?

We’re picking up more debt of course! The same poll found that Canadians are spending more on home renovations and vacations.  When money is cheap, we love to borrow more of it!

I’m going to assume some of us don’t like debt so here are 7 ways to pay off your mortgage faster.

Accelerate those payments

The easiest way to pay off your mortgage faster is to set your payment cycle to accelerated bi-weekly. With monthly payments we’re making 12 payments a year, but with accelerated bi-weekly we make 26 payments.

Real-life example:  A mortgage of $350,000 amortized over 25 years at a 3% interest rate will cost us $1656.36 a month.  However, by switching to accelerated bi-weekly payments we’ll pay $828.18 or $1794.35 monthly. ($828.18 X 26 payments, then dividend by 12 months)

The difference is only an additional $137.99 a month but that extra payment will cut almost 3 years off our mortgage.

Increase your payments

Every dollar we put down above our minimum payment goes directly towards the principal of our mortgage.  I would much rather pay off the principal than paying my lender interest.

Let’s use the exact same numbers as before; A mortgage of $350,000 amortized over 25 years at a 3% interest rate with an accelerated bi-weekly payment schedule will cost us $828.18.  We decide to add an additional $100 to every payment making our payments a total of $928.18.  This extra payment combined with our bi-weekly payments has now shaved almost 6 years off our mortgage!

An easy way to increase your payments without ever feeling it is to simply increase your payment whenever you get a raise.

Make a lump-sum payment

Most mortgages allow a lump sum payment once or twice a year up to a certain amount, this is a perfect opportunity to reduce your mortgage further.

But where can we find this extra money?  How about our tax refund, work bonus, employee stock plan or even cash gifts from family.  It doesn’t matter where we get the money, just find some!

Take a shorter amortization

Choosing a shorter amortization is an obvious way to reduce the years on your mortgage but it’s often overlooked.  There’s nothing stopping you from taking a 19-year amortization vs. a 20 year one, you can set it to whatever you want.  Your payments will be higher but you’ll also pay off your mortgage faster.

Renegotiate

Mortgage rates are at an all-time low but it doesn’t just benefit those of us who are currently in the market for a home.  If you’re a few years into your mortgage it’s still possible to take advantage of these low rates by re-negotiating.

Yes, we’ll have to pay a penalty fee to break our mortgage but we could potentially end up saving tens of thousands of dollars in the long run.  There are tons of lenders out there that would be happy to take our business. . . err money, so work with a mortgage broker to find the best rate and term.

Skip the renovation

If your goal is to pay down your mortgage, doing renovations can set you back. I get that people want to update their homes but just understand, but it comes at a cost. If you have a bunch of money lying around, doing renovations could immediately increase the value of your home. However, if you need to borrow cash to do those renos, you’re just increasing your debt.

Borrow less

Lenders are more than happy to lend us an insane amount but just because they offer to lend us $700,000 dollars or whatever should we take it?  NO, never take the maximum amount offered.

I don’t care what the lenders say or how much they say we can afford, this is what we need to know. Lenders don’t care about how we plan to pay for our children’s education, how we will fund our retirements, where we’ll get the money to make home repairs, or how we’ll be able to afford a vacation; they only care about us making our monthly payments.

Final thoughts

Interest rates are at historic lows and they can only go up; if you can only afford a home with a long amortization at these rates then it’s a good sign that you probably can’t afford a home.

Think carefully about how much you want to borrow.  This ain’t Trading Spaces, This is real life!