My Articles > Longer Amortizations - Are They Right for You?
In 2006, the Canada Mortgage and Housing Corporation (CMHC) and Genworth Financial Canada extended amortization periods on high ratio mortgages up to 40 years. The majority of Canadian financial lenders followed suit and started offering extended amortizations on their mortgages.
Now, how does this new program affect someone like yourself? Before we answer this, let's take a look at how the amortization actually works.
Amortization is defined as the number of years over which you are required to pay off your mortgage. Until recently, standard amortization used to be 25 years. For example, if you took a $250,000 mortgage at the rate of 5% compounded semi-annually, you would pay off your mortgage in 25 years by making monthly payments of $1,455.
Mortgage amortization and mortgage payments are inverse: The shorter the amortization - the higher the mortgage payment and vice-versa. If the amortization in our example was reduced to 20 years, the monthly payments would increase to $1,643, which would result in interest savings of almost $42,000 over the 20 year period.
Now that we know how amortization works, let's take a look at some benefits of extended amortization.
1.
Home ownership becomes more affordable and accessible.
If you were not able to afford the house of your dreams because the banks were turning you down due to your low income, you could now be approved under a longer amortization. By increasing the amortization from 25 to 40 years in our earlier example, monthly payments would be reduced to $1,198. If your income was not able to support a $1,455 monthly payment, it now might be able to support a lower payment of $1,198.
2.
Longer amortization could be used as a security blanket.
For those individuals with variable income or non-secure employment, having a longer amortization might be something to fall onto should their financial situation change. Those individuals could get their mortgage approved under a longer amortization and then simply increase their monthly payments to a desired amount on the closing day. They will still obtain the payments they originally wanted, except that now they will have the option of lowering their payments to the original amount under a longer amortization, should they need to.
3.
Longer amortization frees up your cash flow for other things.
You could be paying for your children's education or a wedding… You might have to use your line of credit or even a credit card to take care of these expenses. Well, if you follow the golden rule of any sound financial planning, you should be paying out first the debt that has the highest interest rate. By lowering the payments on your mortgage you would increase your cash flow, which could be used to pay those higher interest bearing debts first.
Now, let's take a look at some downsides of extended amortization.
1.
Paying a mortgage over a longer period of time costs you more.
As mentioned earlier, having a longer amortization means that you are repaying your debt to the bank over a longer period of time, resulting therefore in a higher cost of borrowing. Using our earlier example of $250,000 mortgage, the cost of borrowing based on a 25 year amortization is $186,205, while under a 40 year amortization is $324,565.
2.
Insurance Premiums on amortizations over 25 years are higher.
If you are buying a house with less than 25% down payment, you are required to pay an insurance premium on your mortgage to CMHC or Genworth, which varies depending on the percentage of the down payment. For example, if your down payment is 10%, you will have to pay a one-time insurance premium equivalent to 2% of your total mortgage. For extended amortization scenarios, the premium is increased by 0.2% for every additional 5 years of additional amortization (2.2% on a 30 year amortization, 2.4% on a 35 amortization and so on). If your down payment is 25% or more, you are subject to a smaller insurance premium, usually around 1% of the total mortgage.
3.
Your unique application might not qualify for extended amortization.
Certain properties or products do not qualify for extended amortizations. For example, banks might not offer extended amortizations on Home Equity Lines or Credits or rental properties. It is always a good idea to talk to your bank or a mortgage broker and verify whether the extended amortization could be applied in your unique financial circumstance.
