This article has been updated from a previous version.
According to the latest quarterly results from three lenders, some of the biggest Canadian banks have seen a rapid increase in the number of mortgage amortization periods longer than 30 years.
The Globe and Mail reports that in November, residential mortgages with amortizations extending beyond 30 years made up the following shares at BMO, CIBC, and RBC:
BMO: 31%
CIBC: 30%
RBC: 27%
These numbers are up significantly from April, when 30-year amortizations made up only 11% of BMO’s mortgage portfolio and 12% of mortgages at RBC and CIBC.
Shorter amortizations can help borrowers accumulate home equity faster and pay less interest over time, but Canadians may find them less appealing given that they’re already struggling with higher mortgage payments in the wake of recent rate hikes from the Bank of Canada.
Benefits of a longer mortgage amortization
After the 2008 recession, the Canada Mortgage and Housing Corporation (CMHC) progressively lowered the maximum amortization on insured mortgages. Formerly, homebuyers could amortize their mortgage over 40 years. Today, homebuyers who don’t put at least 20% down on their home are limited to a maximum amortization of 25 years, while those with uninsured mortgages can have a 35-year amortization.
If you’re stretching your budget to cover the higher monthly mortgage payments of a short amortization, you may be in over your head. If you unexpectedly lose your job or get sick, you could find it difficult to make those payments.
A longer amortization can be seen as a form of risk management. Your monthly payments won’t be as high with a 30-year amortization, making unexpected financial woes more manageable. However, you will pay more in interest over time.
This doesn’t mean you can’t pay off your mortgage quicker and save on interest payments. Most lenders allow generous prepayment privileges, which means you can usually make extra lump-sum payments once or multiple times a year. You can also increase your payment frequency to bi-weekly or even weekly and pay more than the minimum monthly payment.
Amortizing over 30 years lowers your payment to something more manageable. Then you can pay the principal faster (within the limits of your mortgage contract) when you know you have the extra funds. You can always stop the prepayments in the event of a financial emergency.
A longer amortization with lower monthly payments may also give you wiggle room to focus on other debts. Since your mortgage is one of the cheaper forms of debt, it makes sense to focus on paying off your high-interest debt, like credit cards, first.
Alternatively, you may have other financial priorities that give a greater return on your investment than a mortgage. For example, you may want to consider putting more money into your Registered Retirement Savings Plan (RRSP), or other investments, if the return is higher than the interest on your mortgage. If your mortgage payments are taking up too much of the budget, you may not be able to manage this. A longer amortization may offer the financial flexibility you need.
Benefits of a shorter mortgage amortization
If you’re afraid to check your bank account at the end of the month, you may not be disciplined enough to benefit from a long amortization.
By contrast, a shorter amortization may serve as forced savings and reduce the amount of disposable income you spend. If you can afford the higher monthly payments of a shorter amortization, you can save thousands in interest.
On the other hand, if you consistently use the spare money to contribute to your RRSP and investments, you may be able to take advantage of the interest rate differential between those savings vehicles and your mortgage.
A shorter amortization allows you to pay down more of your mortgage principal sooner and pay less interest overall. Plus, you can always extend your amortization later, if need be, to help lessen the impact of higher rates.
Using the RATESDOTCA mortgage payment calculator, here’s an example that illustrates the interest savings of a shorter amortization. If you have a $500,000 mortgage at an interest rate of 4.8%, your monthly payments will be $2,851 and you will pay around $355,408 in interest over a 25-year amortization period. If you choose a shorter amortization of 20 years, you will see those monthly payments rise to $3,232, but you would pay $79,763 less in interest on the same mortgage amount, for a total interest of $275,645.
Choosing the right path for you
Tools like the RATESDOTCA mortgage payment calculator can help you find a starting budget by factoring in your gross household income and expenses. From here, consider your financial habits, level of discipline and priorities.
The lower monthly payments that come with a longer amortization can be useful for those who work on commission or have inconsistent income, first-time homebuyers on a budget and those wishing to invest their disposable income.
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