The difference between the Term and Amortization Period.

01.08.24 09:33 PM

Episode # 31 of the Mortgage Foundations Podcast

When shopping for a new mortgage, a common source of confusion is the difference between the mortgage term, which is normally 1 to 5 years, and the amortization period, which is normally 25 or 30 years.

The basic explanation for the difference between the two timelines is that the mortgage term is the length of the current mortgage contract, and the amortization period is the total life of the mortgage. A typical insured mortgage in Canada features a 5-year term and a 25-year amortization period. There are mortgage terms as long as 10-years in Canada; however, the majority of mortgages feature a 5-year term or less.

Throughout the life of a mortgage, it is expected that there will be multiple terms as the mortgage is renewed with the same lender or even when switched over to a new lender. A great example of the difference between the term and amortization period is to think of a pizza. Basically, the whole pizza would represent the amortization period, and each slice would represent each term. Using the typical insured mortgage of a 5-yerm term and 25-year amortization, 5 slices, or terms, would make up the whole pizza, or amortization period. Considering that not all terms would be equal, and clients can elect to have a shorter or longer term at renewal time, the slices may not all be the same size.

The mortgage term is the time that the mortgage contract is in effect and represents the period that both you and the lenders are committed to for the mortgage, its rate, and the terms and conditions of the mortgage. Mortgage terms typically range from 1 to 5 years; however, can be as short as 6 months and as long as 10 years. Typically, a shorter term will feature a higher rate of interest versus a longer term up to 5 years, which commonly features the lowest interest rates. Longer terms, such as 7 and 10 years, may also feature a higher interest rate as well.

At the end of the mortgage term, you will have the opportunity to renew your mortgage with the current lender or have your mortgage broker look for other options to potentially switch your mortgage to a new lender or look at potential refinancing options if required. The renewal date is when it is recommended to make any changes in order to limit your exposure to potential fees and penalties.

The mortgage amortization period is the time that it would take to payoff the mortgage in full. The amortization period is an estimate and is based on the current interest rate; which may change upon future renewals. Amortization periods on new mortgages are typically 25 or 30 years, with 25 years being the maximum amortization period for an insured mortgage with less than 20% down payment. Although 25 to 30 years is the most common amortization period for mortgages; some alternative lenders do offer amortization periods of 35 years or more.

When it comes to how amortization affects your interest cost, keep in mind that the shorter the amortization, the higher the payment and the lower the interest. The benefit to a longer amortization is that your payment will be lower than compared to a shorter amortization; however, the offset is that your interest expense may be higher if you don't take advantage of prepayment privileges throughout the life of the mortgage. When considering a longer amortization period, you should discuss this with your mortgage broker and ensure that the increased cash flow resulting from the lower payments is worth the possible extra expense in interest. A longer amortization period can add tens of thousands of dollars to the cost of your mortgage and options should be understood ahead of time.

In conclusion, the mortgage term is the time that your mortgage contract with your lender is in effect and comes up for renewal at the end of the term, versus the amortization period, which is the length of time that it would take to completely payoff the mortgage based on the interest rate at the start of the term. A shorter amortization period can result in interest savings; however, it will feature a higher payment and reduced cash flow; whereas a longer amortization period features a lower payment with possible higher interest costs. Prepayment privileges can be used to lower the effective amortization of the mortgage and save on interest costs.

Mortgages Foundations