Mortgage Amortization Periods – Which is Best?
When it comes to monthly bills, there is no getting around the fact that your mortgage payments are going to be among the biggest. And it’s the amortization period on your mortgage that determines just how big these payments will be. This is why the amortization period is among one of the more vital details that you can discuss with your lender.
Whether you opt for a longer amortization period, where you pay less each month, but spend longer (and accumulate more interest paying it off) or you go the shorter route with the goal of saving more money, both options have benefits and drawbacks.
What Exactly is an Amortization Period?
Regardless of how much of a loan you take out, your loan balance will be “amortized” over a set number of years. Every monthly payment that you make goes towards paying off your principal portion, as well as interest. The longer your amortization period the more interest you pay.
Essentially, your mortgage amortization basically averages out all the payments you would need to make over a certain amount of time until the entire loan amount is paid back in full.
Term vs Amortization
Period
It is important that you don’t confuse your amortization period with your
mortgage “term”. The term of your mortgage refers to the length of time that
your mortgage remains in effect. Once that time expires, you’ll have to renew
your mortgage at new terms, but your amortization period will remain the same
unless you decide to actually refinance.
Short-Term Amortization
Periods
Amortization periods that are only 5, 10 or 15 years in length are considered
to be short-term. Because this is a shorter amortization period, the entire
loan amount will need to be paid off in that quicker time period.
There are a few reasons why a lot of people opt for a shorter amortization period. The primary reason being that the financial freedom of completely owning your home comes so much quicker. Another benefit to a shorter amortization period is that it generally comes with a lower interest rate, saving the borrower a significant amount of money. In fact, signing up for a short-term mortgage can help you lock into a rate as much as one percentage point lower than a long-term mortgage.
Long-Term Amortization
Periods
In many areas, the maximum amortization period for home loans that have
mortgage insurance, those with less than a 20% down payment, is 25 years.
For loans that were made with at least a
20% downpayment the maximum is 30 years. In other words if you can come up with
a minimum 20 percent down payment on your home purchase, you may be able to
qualify for a 30-year amortization period. If your down payment is less than 20
per cent of the purchase price of your home, the longest your amortization
period can be is 25. The lower down payment is why longer amortization periods
like 25 years are very popular among borrowers who may have tighter budgets to
stick to. Lower monthly mortgage payments over a longer time period are
especially beneficial for a lot of first-time homebuyers who may have even less
money to play around with because they are just starting out.
Final Thoughts
The
reality is that the choice you make between a short-versus a long-term
amortization period comes down to your specific financial situation. If you
have the finances to comfortably make higher mortgage payments, then perhaps a
shorter amortization period might be a wiser choice, especially when you
consider how much money you can save over the long run.
However, if you worry that your budget might not allow for higher payments, a long-term amortization might be better. While it may cost you more at the end of the day, your ability to make your payments on time every month is critical and is therefore a crucial factor to consider.