Understanding Mortgage Fundamentals – Term vs. Amortization
Most prospective home buyers are generally confused regarding the two terms namely mortgage term and amortization. Therefore, it is important to know about Term vs. Amortization to be able to move ahead with the mortgage process.
A typical mortgage in Canada comes with a 5 year term and a 25 year amortization period. Mortgage term can be understood as the length of the term you are committed to a particular mortgage rate, lender and conditions given out by the lender.
On the other hand, mortgage amortization refers to the length of the time it takes to pay off the mortgage in full. The time frame of a mortgage term can vary between 6 months and 10 years depending on the mortgage product you buy. The maximum length of a CMHC insured mortgage is 25 years, while it is 35 to 40 years in case of non CMHC insured mortgage plans offered by some money lenders.
Choose Mortgage Term Carefully
The mortgage term you choose is sure to have a direct impact on your mortgage rate. Historically, short term mortgage rates are lower than long term mortgage rates. You can say that the function of a term with respect to a mortgage is like that of a reset button. When the term is up, you will have to renew your mortgage on the principal amount. This must be done at a new rate that is available at the end of the term. The earlier maximum amortization period was 35 years in Canada.
On July 9th 2012, this was reduced to 25 years. Longer amortization periods will invariably bring down your monthly payments since you are paying off your mortgage over a more number of years. However, you will have to pay more interest over the mortgage during the life of the mortgage.
Reduction in Minimum Amortization Period
The reduction with respect to the maximum amortization period was announced by Minister Flaherty that brought down the same from 30 to 25 years. CMHC insurance is necessary on all home purchases with a down payment of 20% or less. The implication is that if you are putting more than 20% on your down payment, then it is most likely that some money lenders will accept the amortization period of more than 30 years. Even before this move, the maximum amortization period was reduced from 35 to 30 years.
Canadian Government Promotes Safe Mortgage Lending
If they can afford, an overwhelming number of home buyers prefer to go for shorter amortization periods though it would increase the monthly payments. This is because there is a popular belief that this arrangement promotes a positive saving behaviour and considerably brings down the total interest payable in the long run. The prepayment privileges set out by the money lender can guide your decision as to whether you can shorten the amortization period which will increase your regular monthly payments and also considering the option of putting lump sum payments towards the principal without incurring any penalties.
Statistics reveal that a number of Canadians are taking advantage of the prepayment options in front of them. Therefore the knowledge about Term vs. Amortization is necessary for home buyers to decide on the beneficial strategy that will suit them.
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