Obtaining a mortgage for the first time can seem overwhelming. There are so many things to consider when shopping for a mortgage besides just your mortgage rate. A lot of first-time homebuyers confuse their mortgage amortization period and term. Although both can be the same length of time, oftentimes they’re not. If you aspire to be mortgage-free, knowing the difference between the two is important.
Your mortgage term is the length of time in which you are legally bound by the terms of your mortgage. Mortgage terms vary in duration starting at six months to as long as 10 years (although most homebuyers choose a five-year term). Under normal circumstances, the longer your mortgage term, the higher your mortgage rate will be. For example, a five-year mortgage term usually has a higher mortgage rate than a two-year mortgage term. When your mortgage term finishes, you can renew your mortgage – or if you have the cash, you can pay off your outstanding mortgage balance.
If you have a fixed-rate mortgage, your mortgage rate will remain the same throughout your term. With a variable-rate mortgage, while the mortgage rate may change based on the prime rate, the spread will remain the same. For example, if you mortgage rate is prime rate minus 0.8%, and prime rate is 3%, your mortgage rate will be 2.2% (3% - 0.8% = 2.2%), but if prime rate goes up to 3.5%, your mortgage rate will jump to 2.7% (3.5% - 0.8% = 2.7%). In this case, more of your money will go towards interest and less toward the principal.
Not to be confused with your mortgage term, your amortization period is the length of time until your outstanding mortgage balance is paid off. Once your amortization period is over, you can have a mortgage burning party to celebrate achieving mortgage freedom.
Your regular mortgage payment is based on your amortization period. Previously homeowners could choose an amortization period as long as 40 years, but the federal government has reduced the amortization period in recent years. Buyers with a high-ratio mortgage (a down payment between 5% and 19.99%) can choose a maximum amortization period of 25 years, while buyers with a conventional mortgage (a down payment of 20% or more) can choose a maximum amortization period of 30 years.
Contrary to popular belief, your amortization period isn’t set in stone; you have the option of choosing a shorter amortization period. While a longer amortization period will lower your mortgage payment, you’ll end up paying a lot more interest over the life of your mortgage.