Comparing Mortgage Terms and Amortization Periods
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When choosing a mortgage in Canada, knowing the difference between a mortgage term and an amortization period will help you better understand how each affects your mortgage payments and interest costs. The mortgage term is the length of time you’re committed to a specific lender, interest rate, and payment conditions, while the amortization period is the time it will take to repay the mortgage in full.
Mortgage terms and amortization periods can greatly affect the interest you pay over the life of your mortgage. Understanding each component’s role in your mortgage can help you save on interest-carrying costs, structure mortgage payments to meet your financial goals, and help you make better decisions regarding your mortgage.
Key Takeaways
- Mortgage terms determine the duration of your lender agreement, while amortization periods determine the life of the loan.
- Mortgage terms can be shorter, lasting from 6 months to 3 years, or longer, lasting from 5 to 10 years.
- Choosing the right combination of mortgage term and amortization period can help you maximize interest savings.
What Is a Mortgage Term?
A mortgage term is the length of time you’re locked into the terms and conditions of your mortgage agreement, including the interest rate. The interest rate you choose during each mortgage term will influence the size of your mortgage payments and the total interest paid over the life of the mortgage.
In Canada, mortgage terms can range from 6 months to 10 years, though 5-year terms are typically the most popular choice. At the end of each mortgage term, you must renew, refinance or pay your mortgage off in full. Choosing a longer or shorter term depends on your financial goals, risk tolerance, and market conditions.
Short Mortgage Term
Short mortgage terms generally range from 6 months to 3 years. These terms are ideal for borrowers seeking flexibility or anticipating changes in their financial situation. Prepayment penalties on short-term fixed-rate mortgages will be lower than those on long-term fixed-rate mortgages since penalties are calculated based on the months remaining on the term.
However, choosing a shorter term requires you to renew your mortgage more frequently, which could expose you to higher interest rates and significantly impact your mortgage payments if your rate at renewal increases.
Convertible Mortgage Term
This type of short mortgage term allows you to convert to a longer-term without penalty. These mortgage terms are typically 6 months, giving you the flexibility of a shorter term. They can be useful if you anticipate interest rates will decrease within 6 months. However, if rates increase before the end of the convertible term, you may be forced to renew at a higher rate.
Long Mortgage Term
Long mortgage terms generally range from 5 to 10 years. These terms are ideal for borrowers who want stability and prioritize consistent payments, as mortgage payments on long-term fixed rates are locked in for longer.
However, longer terms could mean you miss out on interest cost savings if interest rates fall while locked into a fixed term. You will pay a higher prepayment penalty than shorter terms if you have a fixed rate and need to break the mortgage closer to the beginning of the term.
What Is an Amortization Period?
The amortization period is the total time it takes to pay off your mortgage balance. Typically, amortizations are 25 years for borrowers with less than 20% downpayment. However, certain circumstances and qualifying criteria allow borrowers to choose a 30-year amortization, giving you an extra 5 years to spread out mortgage payments.
The amortization period influences how much you will pay for each mortgage payment during a term and the total amount of interest you will pay over the entire life of the mortgage. Shorter amortizations increase mortgage payments but reduce the total interest you will pay over the life of the loan. In comparison, longer amortizations will lower mortgage payments but increase the total interest you will pay.
How Mortgage Terms and Amortization Periods Affect Interest Costs
The mortgage term and amortization you choose determine the amount of interest you will pay over the life of the mortgage. For example, the tables below compare the interest paid on a 3-year term vs. a 5-year term on a $300,000 mortgage over a 25-year or 30-year amortization period. We are using the historical average posted 3-year and 5-year mortgage rates from 1994 to 2024 to cover the past 30 years. We assumed monthly mortgage payments and that you renewed each term for the same length of time.
| 3-Year Fixed Rate | 25 Year Amortization | 30 Year Amortization |
|---|---|---|
| Interest Rate | 8.86% | 8.86% |
| Interest Costs (End of year 3) | $76,910 | $77,441 |
| Interest Rate | 6.54% | 6.54% |
| Interest Costs (End of year 6) | $130,962 | $132,920 |
| Interest Rate | 8.17% | 8.17% |
| Interest Costs (End of year 9) | $193,456 | $198,835 |
| Interest Rate | 5.86% | 5.86% |
| Interest Costs (End of year 12) | $234,066 | $243,381 |
| Interest Rate | 6.42% | 6.42% |
| Interest Costs (End of year 15) | $272,216 | $287,826 |
| Interest Rate | 4.62% | 4.62% |
| Interest Costs (End of year 18) | $294,173.15 | $316,021 |
| Interest Rate | 3.91% | 3.91% |
| Interest Costs (End of year 21) | $306,987 | $335,730 |
| Interest Rate | 3.42% | 3.42% |
| Interest Costs (End of year 24) | $312,401 | $348,724 |
| Interest Rate | 3.47% (Based on 1 year remaining on the amortization) | 4.23% |
| Interest Costs (End of year 25) | $312,805 | – |
| Interest Costs (End of year 27) | – | $358,911 |
| Interest Rate | – | 3.49% |
| Interest Costs (End of year 30) | – | $361,919 |
| Total Interest Cost | $312,805 | $361,919 |
| Total Mortgage Cost | $612,805 | $661,919 |
| 5-Year Fixed Rate | 25 Year Amortization | 30 Year Amortization |
|---|---|---|
| Interest Rate | 9.41% | 9.41% |
| Interest Costs (End of year 5) | $134,370 | $135,980 |
| Interest Rate | 7.52% | 7.52% |
| Interest Costs (End of year 10) | $231,881 | $238,547 |
| Interest Rate | 6.25% | 6.25% |
| Interest Costs (End of year 15) | $298,657 | $314,356 |
| Interest Rate | 5.70% | 5.70% |
| Interest Costs (End of year 20) | $340,401 | $370,401 |
| Interest Rate | 4.89% | 4.89% |
| Interest Costs (End of year 25) | $353,926 | $402,950 |
| Interest Rate | – | 5.27% |
| Interest Costs (End of year 30) | – | $416,078 |
| Total Interest Cost | $353,926 | $416,078 |
| Total Mortgage Cost | $653,926 | $716,078 |
Note: Choosing a 3-year term does not always mean saving more than with a 5-year term. This just happens to be the case if you started your mortgage in 1994 and paid it off in full between 2019 (25-year amortization) and 2024 (30-year amortization). This example assumes you chose a 3-year or 5-year term at every mortgage renewal. Past interest rates may not match future rates, and selecting a different term length at each renewal could impact interest-carrying costs and potential savings.
Using Prepayment Privileges to Reduce Interest Costs
Most closed mortgages allow you to make prepayments to reduce your principal balance. Your annual prepayment limit is typically a certain percentage of your original mortgage principal. For example, if you start with a $300,000 mortgage and have a 10% prepayment privilege annually, you can prepay up to $30,000 each year without penalty.
You can make payments directly toward your mortgage principal without penalty as long as you are within your prepayment limit. This can help you reduce your amortization to pay off your mortgage faster and save on interest-carrying costs.
If you exceed your annual prepayment limit, you may be subject to prepayment penalties calculated as 3 months of interest or the interest rate differential (IRD), whichever is greater. This could negate any interest cost savings.
Frequently Asked Questions
What happens when my mortgage term ends?
At the end of your mortgage term, you can renew with your current lender, switch lenders, refinance, or pay off your mortgage.
Can I switch lenders mid-term?
You can switch lenders in the middle of your mortgage term, but doing so is considered breaking your mortgage, which typically results in penalties. It’s valuable to weigh the cost of the penalty and switch fees against the cost savings from switching to a new lender in the middle of your mortgage term.
What’s the difference between a mortgage term and an amortization period?
The mortgage term is the time your interest rate and agreement with your lender are in effect, while amortization is the total time it will take you to pay your mortgage in full.
Final Thoughts
Choosing the right mortgage term involves balancing flexibility, stability, and cost. Short terms offer greater adaptability and cost savings should interest rates decrease, while long terms provide payment consistency, stability and protection from rising rates.
Choosing the right amortization period involves weighing the pros and cons of extending your amortization. Longer amortizations can help lower mortgage payments but will result in more interest being paid over the life of the loan. However, using your prepayment privileges can help offset these additional interest costs if you choose a longer amortization.
Assess your financial goals and consult a mortgage professional to make the best choice for your situation. Contact our mortgage professionals to explore your options and secure the term and amortization that align with your financial goals.
