How long should I take to pay off my mortgage? What term is best to ask for?

The Mortgage Talk is an article series designed to help you negotiate life’s largest purchase, your mortgage. In the last segment of Mortgage Talk, we discussed the difference between fixed and variable rates for your mortgage, and which one is ultimately best for you. In this piece, we will switch gears and invest some time explaining how you can get  a better deal and save a ton of money.

Two ways that time is on your side

1. Your amortization period is the total length of time you agree to take to bring the balance of the mortgage to $0 which is typically 25 years in Canada. While intuitively we would like this number to be as small as possible, the shorter the amortization period the larger your payments will be– irrespective of the other factors we discuss in the Mortgage Talk series.

Adjusting your amortization period has a direct effect on the portion of your payments that go towards principal as opposed to interest. If you think about your total interest paid as the fee your lender charges you for borrowing the money, the sooner you can pay your lender back, the smaller this fee is.

As an example, if you put 10% down on a $450,000 home in 2017, the following would illustrate your annual payment breakdown by principal paid vs. interest paid:

Year Total Paid Principal Paid Interest Paid Balance
2018 $22,096 $12,244 $9,851 $402,476
2019 $22,096 $12,543 $9,553 $389,933
2020 $22,096 $12,848 $9,248 $377,085
2021 $22,096 $13,161 $8,935 $363,924
2022 $22,096 $13,481 $8,615 $350,443
Total (term) $110,479 $64,277 $46,203 $350,443

As you can see, interest payments are much larger earlier on.

2) Your term describes the time period for which your agreed interest rate is in effect. When the term expires you and the lender will renegotiate a new term. Unlike your amortization period, your term has a direct effect on the interest rate you can negotiate- both fixed and variable. All other things being equal, lenders will generally give you a more favourable fixed interest rate on shorter terms because it gives them a chance to renegotiate sooner if interest rates rise shortly after your agreement.

If you want a term greater than 5 years (a fairly standard term length), the fixed rate they offer will be higher to hedge the lender’s risk of losing money should interest rates spike. If you want a variable term however, the reverse is often true. Of course if interest rates somehow continue to fall, this can work to your benefit as you are able to ride the falling rates.

Call to action

Here are recommended actions to take:

1) Determine your amortization period. Most choose the 25 year option.

2) How much of a down payment can you afford, remember the larger the down payment the less interest you will pay. And you save big time if you have a 20% down payment as you won’t need to pay the CMHC insurance.

3) Decide what level of risk you are willing to accept; is fixed or variable terms better for you, how long do you want to negotiate your term

4) Remember to shop around for mortgages, there are chartered banks, private mortgage lenders and online ones as well. Find someone you trust and feel comfortable dealing with.

5) Join the Simple Money Living community and be among us that are Living, Simple, with Money!

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