What Are Mortgage Terms and Amortization Periods?
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Mortgage terms and amortization periods are two critical components of any mortgage in Canada. While they may seem similar, they have distinct roles in shaping your mortgage payments and total mortgage costs. Understanding how each affects your mortgage can help you make better financial decisions, save on interest, and structure your payments to fit your financial goals.
Key Takeaways
- Mortgage terms are the length of your mortgage contract, often between 6 months to 5 years.
- Amortization periods define how long it will take to fully pay off your mortgage, typically 25 to 30 years for prime mortgages.
- Choosing the right mortgage term and amortization period for your financial circumstances could save you thousands in interest-carrying costs.
What Is a Mortgage Term?
A mortgage term is the length of time that your mortgage contract with your lender remains in effect. During the term, if you have a fixed mortgage, your interest rate and contract terms are locked in place and cannot be changed without incurring penalties. If you have a variable mortgage, your interest rate will adjust with changes to the lender’s prime rate, but contract terms will be locked in place and cannot be changed without a penalty. However, your lender may allow you to convert your variable rate to a fixed rate without penalty.
Mortgage terms in Canada typically range from 6 months up to 10 years, with 5 years generally being the most common term selected. You must renew your mortgage at the end of each term unless you fully pay off the remaining balance. Each renewal allows you to renegotiate your interest rate or switch lenders for better rates and contract terms.
Example:
If you choose a 5-year term with a fixed rate of 4%, your mortgage payments and interest rate will remain the same for the entire 5 years. However, you could change to an accelerated payment frequency or use your prepayment options to increase your regularly scheduled payments. After the term ends, you must renew your mortgage, which means you may be able to negotiate for a lower interest rate, depending on market conditions.
What Is an Amortization Period?
An amortization period is the total time it takes to repay your mortgage balance in full. The typical amortization period for homebuyers with less than 20% downpayment in Canada is limited to 25 years. If you make a downpayment of 20% or more or meet the eligibility criteria for a longer amortized insured mortgage, you may choose a 30-year amortization period.
The amortization period influences the size of your mortgage payments and the total amount of interest you’ll pay over the life of your mortgage. A longer amortization period results in lower mortgage payments but higher overall interest costs, while a shorter amortization period increases monthly payments but reduces total interest.
Example:
For a $300,000 mortgage at 4% interest:
- 25-year amortization: Monthly mortgage payments of $1,578 with approximately $173,000 paid in total interest over the amortization period.
- 30-year amortization: Monthly mortgage payments of $1,427 with approximately $214,000 paid in total interest over the amortization period.
Types of Mortgage Terms in Canada
Short-Term Mortgage
A short-term mortgage typically lasts between 6 months to 3 years. These mortgages provide flexibility, allowing borrowers to take advantage of lower interest rates if rates are anticipated to fall in the short term. Prepayment penalties on short-term fixed mortgages will also be lower than on longer-term fixed mortgages as they are calculated on the remaining months. However, shorter terms require you to renew your mortgage more frequently, exposing you to potential interest rate increases.
- Pros: With more frequent renewals, you have more flexibility to make changes to the mortgage. There are also lower prepayment penalties on fixed mortgages if you need to break the mortgage before the end of the term.
- Cons: Frequent renewals can lead to fluctuations in your mortgage payments. More exposure to changes in the financial markets with frequent renewals may mean you will pay a higher interest rate at renewal if rates increase.
Long-Term Mortgage
Long-term mortgages usually have terms of 5 years up to 10 years. They offer stability, as your interest rate and payment amount are locked in longer. However, you may miss out on lower interest rates while locked in. Additionally, you will pay a higher prepayment penalty than shorter terms if you have a fixed rate and need to break the mortgage before the end of the term.
- Pros: Longer terms provide mortgage payment stability since you’ll know exactly how much you will pay over the term. The less often you need to renew, the less often you need to renegotiate a new rate.
- Cons: You could miss potential interest savings if locked into a higher rate. The prepayment penalties will be higher for breaking the mortgage before the end of the term if rates have lowered, especially if you are closer to the beginning of a long-term mortgage.
Convertible Term Mortgage
This short-term mortgage type allows you to convert to a longer-term mortgage without penalties at any point during the term. Convertible mortgages are ideal if you want the flexibility of a short-term mortgage (typically 6 months) or mortgage rate forecasts expect interest rates to decrease.
- Pros: The flexibility of a short-term mortgage with the option to switch to a longer term without penalty.
- Cons: If interest rates increase at the end of the 6 months, you could be required to renew at a higher interest rate or pay off the mortgage.
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How Mortgage Terms Affect Interest Costs
The mortgage term you choose is critical in determining your interest rate and the amount of interest you may pay over the life of the mortgage. Choosing the right term based on your financial situation and market conditions can significantly impact the overall interest you pay on your mortgage.
Example:
For a $300,000 mortgage, let’s compare what you would have paid in interest carrying costs for a 25-year amortization if you chose a fixed-rate 3-year term or a 5-year term in 1999 when you first took out the mortgage and finished paying it off in 2024. We assume monthly mortgage payments and that you renewed for the same term each time you were up for renewal.
| 3-Year Fixed Rate | |
|---|---|
| Interest Rate | 7.34% |
| Interest Costs (End of year 3) | $63,619 |
| Interest Rate | 6.24% |
| Interest Costs (End of year 6) | $114,662 |
| Interest Rate | 5.56% |
| Interest Costs (End of year 9) | $156,428 |
| Interest Rate | 6.92% |
| Interest Costs (End of year 12) | $202,828 |
| Interest Rate | 4.29% |
| Interest Costs (End of year 15) | $227,510 |
| Interest Rate | 3.69% |
| Interest Costs (End of year 18) | $244,132 |
| Interest Rate | 3.48% |
| Interest Costs (End of year 21) | $254,832 |
| Interest Rate | 3.79% |
| Interest Costs (End of year 24) | $260,444 |
| Interest Rate (Based on 1-year remaining on the term) | 7.15% |
| Interest Costs (End of year 25) | $261,225 |
| 5-Year Fixed Rate | |
|---|---|
| Interest Rate | 7.52% |
| Interest Costs (End of year 5) | $106,785 |
| Interest Rate | 6.25% |
| Interest Costs (End of year 10) | $185,713 |
| Interest Rate | 5.70% |
| Interest Costs (End of year 15) | $244,063 |
| Interest Rate | 4.89% |
| Interest Costs (End of year 20) | $277,950 |
| Interest Rate | 5.27% |
| Interest Costs (End of year 25) | $291,617 |
Note: This example does not imply that you’ll always save with a 3-year term compared to a 5-year term. It just happened to be the case for the last 25 years (if you got a mortgage in 1999 and stuck with a 3-year term at each renewal with a final 1-year term). Past interest rate performance may not match future rate performance, and choosing different terms for each renewal could impact savings.
How Amortization Periods Impact Costs
A longer amortization period reduces your mortgage payments since they are spread out and divided up over a longer repayment period. However, this increases the total amount of interest you pay over the life of the loan. A shorter amortization period will do the opposite, increasing your mortgage payments while reducing your total interest costs since you are repaying the mortgage over a shorter timeframe.
Example:
For a $300,000 mortgage at 4%, assuming the interest rate remained the same for the entire amortization, the chart below illustrates how monthly payments decrease the longer the amortization while the interest paid increases.
| 20-Year Amortization | 25-Year Amortization | 30-Year Amortization | |
|---|---|---|---|
| Monthly Payment | $1,813 | $1,578 | $1,427 |
| Total Interest Paid | $135,057 | $173,418 | $213,560 |
| Total Mortgage Cost (Principal + Interest) | $435,057 | $473,418 | $513,560 |
Choosing the Right Mortgage Term and Amortization Period
Selecting the right mortgage term and amortization period depends on your mortgage strategy, financial goals and circumstances, mortgage rates forecast and market conditions. Locking in a longer-term mortgage might be beneficial if you anticipate rising interest rates. However, if rates are expected to fall, a shorter-term mortgage could allow you to renegotiate a lower rate sooner.
Similarly, consider your monthly budget when choosing your amortization period. Opt for a more extended amortization period if you want lower monthly payments. A shorter period is ideal for paying off your mortgage quickly and saving on interest.
Prepayment Privileges and Penalties
Most closed mortgages in Canada allow you to make prepayments up to a certain percentage of your principal without penalty. This can help you reduce your amortization period, pay off your mortgage faster and save on interest. However, exceeding your annual prepayment limit can result in prepayment penalties.
Review your mortgage contract and take advantage of your prepayment privileges, which can help you save on your mortgage’s interest-carrying costs. Stay within your annual mortgage prepayment limits to avoid penalties that may negate any interest cost savings.
Using Mortgage Calculators
Mortgage calculators are valuable tools that can help you estimate your mortgage payments, total interest, and how different amortization periods or mortgage terms will affect your interest rate, mortgage payments, and finances. Most lender websites offer free mortgage calculators to help you compare mortgage carrying costs and potential savings.
Frequently Asked Questions
What is the difference between a mortgage term and an amortization period?
A mortgage term is the time your mortgage contract is in effect, usually between 6 months and 5 years. An amortization period is the total time it takes to repay your mortgage in full, typically 25 to 30 years.
Can I change my mortgage term without affecting the amortization period?
Yes, you can change your mortgage term at renewal without altering your amortization period. However, any changes in payments or rates could affect the amortization and the total interest you pay over time. For example, changing your mortgage payments to an accelerated frequency would decrease your remaining amortization period.
What is the maximum amortization period allowed in Canada?
The maximum amortization period is 30 years, with prime lending for borrowers with a downpayment of 20% or more or who meet the eligibility criteria for insured 30-year amortized mortgages. The maximum for those with a downpayment under 20% and who do not meet the eligibility criteria for a longer amortization is 25 years. However, these amortization limits do not apply to subprime lending.
How does a more extended amortization period impact my interest payments?
A more extended amortization period reduces mortgage payments but increases the total interest paid over the life of the loan.
Are there benefits to choosing a shorter mortgage term?
A shorter mortgage term allows you to renew or renegotiate your mortgage more frequently, potentially helping you take advantage of lower interest rates.
Final Thoughts
By understanding the mortgage terms and amortization periods and their role in your mortgage payments and costs, you can potentially save thousands in interest over the life of your mortgage. Whether you choose a long or short mortgage term or a 25-year or 30-year amortization, having a straightforward mortgage strategy will ensure you make the best choice for your financial future.
Reach out to one of nesto’s mortgage experts for tailored advice to help you find the best term and amortization for your mortgage.
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