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What Are The Key Differences Between Amortization Period And Mortgage Term

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Want to understand the difference between Amortization period and Mortgage term? Read this blog to find out.

Amortization period vs. Mortgage term

Source: Freepik

A mortgage is the most popular for owning a house in Canada. But can you decipher the terms of the home buying or mortgage agreement and transactions? Let us uncover the mortgage term and the amortization period.

Why is there a need for Canadians to know about all the terms associated with mortgage?

A recent study conducted in Canada shows a sharp increase in the average value of mortgages from $223,000 in 2012 (third quarter) to $372,000 in 2021 (third quarter). It corroborates the story that an increased number of Canadians are now buying their homes by obtaining mortgage loans.

However, it is ironic that most new home buyers are ignorant or obscurant. Because of a lack of ample information at their disposal, they often make poor mortgage choices, leading to financial losses.

We are here to help you out, and through this article, you will learn everything about the two most used terms in the mortgage world, which are:

  • Amortization Period 

and

  • Mortgage Term

What is the Amortization Period?

Let us understand this with a simple story that involves you.

  • You are a new homebuyer and are short of money.
  • You have scooped up 20% of the asking price, but you need finance for the rest of the 80%.
  • You approached a lender, and it extended you a mortgage loan for the rest of the amount.
  • Your lender told you to repay this mortgage loan in 25 years.
  • Considering the mortgage rate at which you got the loan and this period of repayment (25 years), your lender calculated your mortgage payment, which you need to pay monthly.

Now, the “amortization period” is nothing but the time that you get from your mortgage lender to repay your mortgage loan. Presently in Canada, a typical amortization period starts from 10-years and goes on until 30-years.

For most homebuyers, especially from a non-financial background, “amortization” often gives them headaches and a sense of technicality. Let us clear the meaning of it.

“Amortization” draws its significance from accounting and finance, where it represents the act of gradually writing off the value of intangible assets.

However, in the world of mortgages, it simply represents the act of writing off a loan amount, installment by installment, month by month, via a consolidated mortgage payment that represents both:

  • The principal amount

and

  • The calculated interest
Mortgage term
Source: Freepik

What Do You Mean By Mortgage Term?

Doing a financing business is risky. We remember the great depression of 1920 and even the global economic crisis of 2008. 

To protect themselves from an interest rate risk (means the risk that the bond yields will change because of a change in the interest rate), every lender usually offers a mortgage loan at an interest rate, which will be re-set at the end of every pre-defined period. 

We know this period as the mortgage term at the end of which:

  • Either it will renew your outstanding mortgage balance on new mortgage terms
  • Or you will be required to make good the outstanding payment in full

Let us understand this concept through a practical example.

Emma is a budding professional and has owned a house for the first time. She was actively searching for homes in the Greater Toronto Area, and her eyes set on a newly built dwelling unit in a building in Burlington, Ontario.

To purchase her dream house, she approached a few lenders and is getting a mortgage loan of $500,000 at a mortgage interest rate of 4% per annum for an amortization period of 30 years. The mortgage term is 5 years.

At the end of the mortgage term:

  • Emma will be required to either pay off her outstanding balance in full 

Or

  • Re-finance the outstanding balance at the mortgage interest rate of that time, which can be higher or lower than the existing mortgage rate (4% per annum).
interest rates
Source: Freepik

What Is the Relationship Between the Amortization Period and the Mortgage Interest Payments?

It is pertinent to note that the amortization period and the interest you will pay throughout your mortgage tenure maintain an inverse relationship with each other.

It translates into the fact that:

  • The higher the amortization period, the higher the amount of total mortgage interest paid by you
  • The lesser the amortization period, the lesser the amount of total mortgage interest paid by you

We can further understand this concept through a practical example.

William is a salaried professional and for the past several months, he is looking to buy out a condominium in the Greater Toronto Area. Finally, he has shortlisted a property at Ellerslie Road, Brampton, Ontario, and is serious about purchasing it.

  • The purchase price of this property is $600,000 
  • William has managed $150,000 or 25% of the purchase price price as a down payment
  • William will take a mortgage loan for the rest of the asking price, which is $450,000

Upon scrutinizing a few of the banks and private lenders operating in his area, he has finally settled at ABC Royal Canadian Bank, which is offering him a mortgage loan at an interest rate of 3.940% per annum in two different versions that are:

  • A mortgage loan with a 25-year amortization period
  • A mortgage loan with a 15-year amortization period

*Ignoring the concept of mortgage term for the sake of simplicity

Now, let us have a look at the amortization schedule to find out the total interest paid under both the options:

Amortization PeriodInterest RateMonthly Mortgage PaymentsTotal Interest Payable
25 years3.940%$2,360$258,115
15 years3.940%$3,315$146,715

Observation

  • One can infer from the table above that in a higher amortization period,
    • Monthly mortgage payments are lower but the total interest payable is higher
  • It happens when you opt for a higher amortization period. The borrowed money stays with you and is used by you for a higher number of years.
  • It prompts the lenders to collect more interest from you as using their money for a longer duration
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