Turns out 2015 wasn’t the year for rising interest rates, in fact we ended up having 2 interest rate cuts. With rates being so low and expected changes to the Home Buyer Plan, many Canadians might be ready to buy in the new year. Low interest rates can be a bit deceiving since home ownership may appear affordable when you’re looking at just the monthly payments.

What astonishes me is that how many people potential homeowners don’t understand how mortgages work. They know that you need one to purchase a home, and that it comes from a lender, but beyond that, many people are absolutely clueless. They don’t really understand what the difference between mortgage amortization and term are, all they focus on is what their monthly costs will be.

The mortgage amortization and term you chose directly affects your payments so why wouldn’t you want to know what they both are?

What is a mortgage amortization?

Mortgage Amortization

The mortgage amortization is the length it will take you to pay back your loan. Many people these days choose a 25 year amortization since it offers lower monthly payments, but that also means you end up paying more in interest. If you choose to amortize your mortgage for less years, you end up paying more every month, but your debt will be cleared much faster.

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 if you can’t even save that small amount, do you honestly think you’e ready for home ownership?

If you have a 20% down payment, then you qualify an amortization as long as 30 years, but again that longer amortization means more interest payments so it doesn’t exactly benefit you. What’s the points of saving 20% and then paying a ton of interest charges over 30 years?

With interest payments being so low, many people are in no rush to pay down their mortgages choosing to invest instead. 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.

[fusion_builder_container hundred_percent=”yes” overflow=”visible”][fusion_builder_row][fusion_builder_column type=”1_1″ background_position=”left top” background_color=”” border_size=”” border_color=”” border_style=”solid” spacing=”yes” background_image=”” background_repeat=”no-repeat” padding=”” margin_top=”0px” margin_bottom=”0px” class=”” id=”” animation_type=”” animation_speed=”0.3″ animation_direction=”left” hide_on_mobile=”no” center_content=”no” min_height=”none”][icon class =”share”] Related: Overlooked costs of buying a home

Mortgage term

Mortgage term refersto 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 your term can be anywhere from 1-7 years.

With interest rates being near all time lows, many people are choosing 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.

What many people fail to understand is that once your term is up, you need to negotiate a new loan from your lender. Those low interest rates you’ve been enjoying will almost definitely 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.

Final word

Home ownership 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 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 more than you can realistically afford. Take the time to learn about all the costs associated with owning a home so you’re well informed when you’re ready to buy.[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

6 Comments

  1. Susan on January 3, 2016 at 12:42 am

    What amazes me is how little most people know about all things financial – mortgages, taxes, RRSPs, TFSAs, interest, leasing, withholding taxes vs actual taxes, etc. Etc. These are not taught in school and for many families the blind are leading the blind since the parents don’t understand these themselves. Kids should be taught how to reconcile a bank account, prepare a simple tax return (on paper so they can see how the numbers were work), reading and calculating from payroll tables, and leasing.

    • Barry Choi on January 3, 2016 at 1:00 am

      Susan,

      Yes it’s pretty insane how such basic financial terms aren’t understood by the majority of people. I wrote this piece about mortgages since I kept getting asked about them. The thing is, if they’re buying a home, they should know this already.

  2. Ashley on January 8, 2016 at 8:24 am

    I just clicked on the button to renew my term for 5 more years. It was painful to give up my current 1.9% rate to go to 2.7% but really, is that such a bad rate? No. Besides, with extra payments I’ve knocked almost 6 and a half years off my 25 year mortgage in 10 years, and hoping it’ll be even more by the time it’s gone.

    • Barry Choi on January 8, 2016 at 8:26 am

      Ashley,

      That’s still a pretty good rate. In the near future you won’t see 5 year fixed rates at less than 3% (still an incredible rate). Awesome job at paying down your mortgage.

  3. Jaymee @ Smart Woman on January 18, 2016 at 2:06 am

    I remember when I was so gung-ho about buying a house because I wanted to “own my first property before 25 years of age” – I’m glad I came to my senses before signing for that house I almost bought last year. I can vouch for the fact that I was only looking at the short-term “how can I get into a house asap” and not so much what would happen in the next 5 or 10 years.

    Now I’ve sat down with my advisor and went over my house buying plan. He agrees with my plan to buy but recommends not paying off my house as soon as possible (which was my game plan before). He recommends I put more money into my investments instead and pay off the house later. We went through the numbers and they completely make sense – understanding the risks of course!

    Long story short – I’m glad I waited on buying a house. And I’m glad I’m learning about different strategies and approaches to home buying. 🙂

    • Barry Choi on January 18, 2016 at 9:33 am

      Jaymee,

      I don’t own yet either, but I definitely used to think the same way. Before I told myself when I got a mortgage I would pay it down as quickly as possible, but with interest rates so low it makes sense to invest some money for the long term. With creative math, any home will seem affordable on a monthly basis.

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