We hear these words often when referring to mortgages, but what do they mean and how do they work? With a proper understanding of the terminology you can save money on your mortgage. So let me show you what I mean….. Term vs. Amortization…These two different words refer to key time periods in a mortgage.
The TERM is the length of time that the mortgage contract, and interest rate are in effect with a specific lender. Most mortgages have a TERM that ranges from 6 months to 5 and sometimes even 10 years.
The AMORTIZATION period, is the length of time that it will take you (at the current payment and interest rate) to pay off your mortgage in full.
The TERM that you choose will have a direct effect on your mortgage rate. A shorter term is usually at a lower interest rate compared to a longer term. From a borrower’s point of view, “term” is really all about forecasting the direction of interest rates. If you believe the rates will drop in the near future, you will likely look at a shorter term. If however, you believe the rates will rise, you would be more inclined to choose a longer term. There are other factors to also consider such as making it a open, closed or variable mortgage. Having an idea of how long you plan to own the property is also something to consider, because breaking a mortgage before the term is up can be very costly.
AMORTIZATION, on the other hand, relates to the rate at which the full mortgage is paid off ( ie. 25 years ). A longer amortization period will reduce your monthly payment because you are able to pay off your mortgage over a greater number of years. Doing so however, means that you will pay more interest over the life of the mortgage. The following chart shows how the difference of 5 years of payments can be significant.
Mortgage Amount $300,000 $300,000
Amortization Period 25 Years 30 Years
Interest Rate 5.1% 5.1%
Monthly Payment $1,762 $1,620
Total Interest $228,580 $339,659
*** The above scenario has a difference of $142 per monthly payment and $111,079 in interest payments by simply changing the Amortization period by 5 years.
A full consultation with your Mortgage Specialist is critical before deciding what mortgage lender and product is best for your real estate purchase. Making sure you understand all the terms and conditions of the mortgage is vital before you sign your agreement. Remember, there is no such thing is a “dumb” question….. except the one you did not ask !!
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