Definition of Amortization Period
Amortization period refers to the time period it will take to repay a mortgage in full. Because mortgage lenders charge interest on mortgage loans, the longer it takes to pay off the mortgage, the more interest one pays. Along with the agreed interest rate, the amortization period is used to calculate the monthly mortgage payment.
A part of each monthly payment will go to pay the interest accrued on the mortgage from the date of the last payment and the remainder will be applied to reduce the principal of the mortgage. As the mortgage principal is reduced, less interest is charged, and more is applied to the principal and over the course of the amortization period, the mortgage balance is reduced to zero.
A shorter amortization period means less interest paid over the life of your mortgage!
Mr. McGillicuddy has a mortgage of $200,000 at 5% interest and a payment of $1067.38. If $1067.38 was paid every month for the life of the mortgage, it would take 360 months, or 30 years, to pay off the mortgage. The 360 month period is referred to as the amortization period.
The amortization period is not to be confused with the mortgage term. In Canada, the mortgage term is usually much shorter than the amortization period, often 3–5 years or less, depending on which mortgage term is selected by the mortgagor. The amortization period is much longer, because it is used to calculate the monthly payment made by the mortgagor, and few buyers can afford to pay off a mortgage in 3–5 years.
For instance, in the example above, if the amortization period is only 3–5 years, to match with the mortgage term, the monthly payment would be $5,989.57. Few could afford to make such a payment. Therefore, the amortization period used to calculate a reasonable monthly payment is usually 25–30 years, although it is possible to choose a lower amortization.
Advantages of Knowing your Amortization Period
As a rule, the shorter the amortization period used to calculate your monthly payment, the higher your payment will be and the less interest you will pay in the long run.
Using the same mortgage amount and interest rate above you can see how a 30 year amortization period will pay much higher interest over the repayment period:
- $200,000 amount 30 year amortization $1067.38 payment $184,257.99 total interest paid
- $200,000 amount 25 year amortization $1,163.21payment $148,962.87 total interest paid
A change from an amortization period of just 5 years will result in $35,295.12 less interest paid. Some borrowers will prefer to have a lower monthly payment, others will prefer to pay more into the principal of the mortgage and have a lower eventual payout.
At First Foundation, our licensed Mortgage Brokers will assist you in selecting the amortization period that is best fits your overall financial plan. In addition, we can provide various scenarios to demonstrate the savings extra payments can make over the life of your mortgage.
If you are interested in learning more about amortization period, please feel free to contact us today!