Mortgage amortization explained: what is it & how does it work?
Mortgage amortization. Term. Payment schedule. Renewal and refinancing. These are all phrases you’ll hear over the lifetime of your mortgage, and they’re all connected. One frequent question people have about mortgages is “What does amortization mean?”
First, what exactly is amortization? The mortgage amortization period explained
So, what is the amortization period? It’s the total amount of time it takes to pay off a loan. The mortgage amortization period is the total number of years it will take to pay your mortgage in full. Typically, this is 20, 25 or 30 years. This seems like a very long time but as with any long-term goal, break it into smaller, more manageable steps.
In the case of your mortgage, these smaller steps are called terms, explained below.
How does mortgage amortization work?
In Canada, you do not negotiate the interest rate for the entire mortgage amortization period, but rather, negotiate it in terms.
Also read: The Mortgage Process & How To Get Approved
Terms are periods of time, commonly six months to five years, where you borrow money from a financial institution at an agreed upon interest rate. At the end of each term, you can renew for another term, move to another financial institution with a new mortgage, or pay your mortgage in full. You continue to renew terms until your mortgage is fully paid.
Your mortgage amortization is also affected by your payments. A portion of each payment goes toward paying down your principal (the original amount you borrowed before interest). The rest goes toward paying interest on your mortgage loan. Even though the payment is the same each month, the ratio of principal to interest will change with each payment. This is because the more you pay on your principal, the less interest is charged. The more money you can put toward your principal, the shorter your amortization will be.
How can you calculate your mortgage amortization?
Amortization is most easily calculated with an amortization calculator or pre-built amortization schedule because the calculations change after each payment. There are several online tools available, including free calculators from financial institutions and the Government of Canada.
Here are a couple you may find useful:
This site offers several types of calculators, including an amortization calculator showing the difference monthly or bi-weekly payments will have on the amortization period.
This site offers a mortgage calculator and creates an amortization table that shows how much of your payment is applied to principal and interest each month.
5 ways to reduce your amortization period
Being mortgage free—that’s the dream for most homeowners. Even if you need a longer amortization period to qualify for a mortgage, there are ways to shorten it. Over time you may get a raise, a bonus, a tax return, or other money that you want to put toward your principal.
Here are 5 ways to chip away at your mortgage:
- Make a larger down payment: While you don’t want to overextend yourself, keep in mind that a larger down payment means you’re borrowing less. Even $5,000 can save you thousands in interest.
- Make bi-weekly payments: When you pay your mortgage once a month, you make 12 payments a year. If your bank offers an accelerated bi-weekly payment option, you will make equivalent of one extra payment per year, which will further shorten your amortization period by paying off your mortgage faster.
- Leave your payment the same if you renew your term at a lower rate: If you renew your mortgage term at a lower rate, you will have the opportunity to make lower payments. You could do that but why not keep your payments the same, and more of the payment will be applied to your principal which means you will be mortgage free sooner.
- Increase your payment amount: Many mortgages have an option to increase your payment amounts once a year. This is ideal, if you can afford it, because those extra funds go directly toward your principal. Even a small increase can make a big difference in the long run. Let’s say your monthly mortgage payment is $1,376 per month. Why not round it up to an even $1,400?
- Take advantage of prepayment privileges: The ability to make a prepayment depends on the mortgage features. With an open mortgage, you can make additional payments at any time. However, with a closed mortgage (most mortgages are closed), check if you have prepayment options allowing extra lump sum payments. Also, there may be an option to make a lump sum payment at the end of the current mortgage term before renewal time.
Mortgage Amortization FAQs
What is the longest amortization period allowed on a Canadian mortgage?
If mortgage insurance is required, the longest amortization period that can be requested is 25 years. Without this insurance, 30-year amortization is possible.
Do I want a longer or shorter amortization period?
The answer depends on your financial situation. A shorter amortization has higher mortgage payments, but over the long term, you save thousands of dollars in interest. If you need the lower payments now, take a longer amortization and be sure you have the option to make extra payments later to decrease the amortization period.
Can you extend the mortgage amortization period if necessary?
The amortization period can be extended, but this is treated as a new application and you will have to qualify for the mortgage all over again. Now, an extra risk factor exists – needing a longer amortization to lower payments.
You probably have other questions about choosing the best mortgage terms for you. Your mortgage broker is an excellent resource to answer any questions you might have about your specific situation.
If you have more questions about mortgage terms and amortization, a mortgage broker is always an excellent source of information and can help with your specific needs.