When you become a homeowner, there are going to be numerous house-related expenses that you’ll need to tackle regularly, from the moment you start paying your mortgage, until the moment you decide to sell your house. And the biggest expense of them all? The mortgage itself. No matter what you’re doing around the house, whether you’re mowing the lawn, or just sitting and watching television, the financial aspect of homeownership should always be somewhere in the back of your mind.
A mortgage allows a Canadian consumer to purchase a house and turn it into their home without having to spend their entire life savings. Instead, they’ll pay for the house in installments every single month for a specific number of years (typically 25-35). This process is known as amortization. However, within the amortization, homeowners will also have a mortgage term, at the end of which they’ll have a chance to renew their mortgage contract. In fact, there’s really only one key difference between a mortgage “term” and an amortization. In the article below, we’ll talk a little bit about that difference, as well as the mortgage payment process.
Making Mortgage Payments
Before we start delving into the differences between a mortgage term and the amortization period, we’ll first talk a bit about how you can expect your mortgage payments to work. When it comes to the mortgage process, interest rates (variable or fixed), lump sum payments (if permitted by lender), and payment methods are going vary according to your chosen lender’s specifications. So, while you’re shopping around for lenders, make sure to ask them about the various options they might offer.
In order to start making regular mortgage payments, you and your lender will typically set up a recurring direct transfer, wherein the funds will be extracted straight from your bank account every time your mortgage payment is due. This will be easy enough, especially if you already have a bank account open with that bank. Although, if you’ve decided to work with a new bank or lender, they will be able to advise you on the best way to make your payments.
Some lenders may also allow you to make lump sum payments at specific times during the length of your mortgage. This means that homeowners will be permitted (usually at the one year mark) to make a one-time lump sum payment toward the principle of their mortgage. A lump sum payment won’t directly affect your monthly payments but it will decrease the total amount of you owe and therefore the length of your amortization period. Simply put, a lump sum payment will help you pay off your mortgage sooner and therefore save on interest.
Keep in mind that almost all lenders do not allow borrowers to make lump sum payments whenever they want and if you do you’ll more than likely be charged a penalty fee. The reason for this is because when you sign a mortgage contract with a lender you’re agreeing to pay them a specific amount of interest, which means they’ll be making a specific amount of money from your mortgage. If you make several extra payments and pay off your mortgage significantly quicker than planned, your lender will make less money from your mortgage.
For ways that you can pay off your mortgage early, read this.
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What Are Accelerated Payments?
Because of the financial convenience it provides, most Canadian homeowners will choose to pay off their mortgage in monthly installments, for a total of 12 payments yearly. To keep things straightforward, let’s say that your monthly mortgage payment is $1,000. That means, with a typical monthly payment plan, you’ll make $12,000 in payments towards your mortgage each year, spread across 25-30 years. So, if your mortgage is $300,000, you should be able to pay it off in 25 years. Just be aware, that housing rates in Canada have been on a steady rise over the last few years, so this figure might be somewhat unrealistic once you factor in interest costs and the varying rates of each province or territory.
However, by choosing “accelerated” payments, you’ll be able to reduce your amortization period. Essentially, by increasing your rate of payment, you’ll be adding extra money toward paying off your mortgage every year. You can choose from accelerated weekly or bi-weekly payments. With either of these choices, you’ll be able to break down your mortgage payments in accordance with how many weeks are in a year, rather than how months are in a year, increasing your payment rate and decreasing your amortization.
What’s the Best Way to Pay Off My Mortgage?
Now comes the fun part, choosing which mortgage payment option is right for you and your finances. There are five mortgage payment options that you can choose from. For simplicity, we’ll use the same very basic example for all five options. Let’s say that your total yearly mortgage payment is $12,000.
Monthly – Simple enough, you’ll divide your yearly mortgage payment by the number of months in a year. This means with this option you’ll make one $1000 mortgage payment each month. Because of the convenience they offer, monthly payments tend to be the most common payment choice for Canadian homeowners.
Weekly – There are 52 weeks in a calendar year. So, choosing this option means that you’ll make 52 mortgage payments per year. For this option, you’ll divide your yearly mortgage payment by ($12,000) by 52 which means your weekly mortgage payment will be approximately $231.
Bi-Weekly – With this option, you’ll be making mortgage payments every two weeks, rather than every week or once a month. If your yearly mortgage payment is $12,000, and there are 26 two week periods in a calendar year, you’ll divide your yearly mortgage payment by 26 and pay approximately $462, every two weeks.
Accelerated Weekly – With an accelerated rate of payment, you’ll save on interest over time and pay off your mortgage sooner. Here’s how accelerated weekly payments are calculated. You take your monthly mortgage payment, which is $1000 and divide it by 4, the number of weeks in a month and then multiply it by 52, the number of weeks in a year. Which means you’ll be making 52 $250 mortgage payments in a year and that totals $13,000. Essentially, you’ll be making one extra payment of $1,000 towards your mortgage in a year and pay off your mortgage quicker.
Accelerated Bi-Weekly – This type of payment works out to be roughly the same as an accelerated weekly payment, except that you will, of course, be making your payments every two weeks instead, which can sometimes be easier to manage.
Have no idea where to start when it comes to buying a house? Click here to visit our Home Buyer’s Guide.
What’s the Difference Between a Mortgage Term and an Amortization?
As we mentioned earlier, there is only one major difference between a mortgage term and an amortization period; the time within which they are completed.
Mortgage Term
A mortgage term refers to the period within which you’ll be mortgaging a house through a single lender, paying the specific rate (principal and interest) you’ve agreed upon, and abiding by the various other terms and conditions listed in your particular contract. A typical mortgage term in Canada can be anywhere from 6 months to 10 years. During that time, you’ll need to make your designated mortgage payments to avoid defaulting.
Strictly speaking, shorter mortgage terms will result in a better rate than longer ones, but again, this depends on your lender. Once your mortgage term is up, you can choose to apply for a renewal contract with the same lender, and deal with whatever changes to your rate and conditions they should put in place, while paying the remaining principal on the house. If you aren’t satisfied with your current conditions or your lender denies your renewal for any reason, your mortgage term will be over and you can move on to another lender.
Find out why your mortgage renewal might be denied by clicking here.
Mortgage Amortization
The mortgage amortization period refers to the length of the overall mortgage, the amount of time it takes you to pay off the full cost of the home. As you go through the years, making mortgage payments, you’ll slowly be amortizing the property. A normal Canadian amortization period depends on the size of the down payment you made and whether or not you had to purchase default mortgage insurance, but it typically a mortgage takes anywhere from 20 to 35 years to pay off.
If your mortgage is considered “conventional”, it means that you made a down payment of 20% or more on the home, and therefore did not have to purchase default mortgage insurance. However, if your mortgage is “high-ratio”, your down payment was at least 5%, but lower than 20%. High ratio mortgages are generally more affordable, depending on how expensive the home is. Then again, since high-ratio mortgages are riskier on the part of the lender, borrowers will then be legally required to purchase default mortgage insurance, in case they aren’t able to keep up with their payments.
For more information about mortgage amortization, read this.
As of 2012, the maximum amortization period allowed for high-ratio mortgages is 25 years and 35 years for a conventional mortgage. The most common example of a mortgage in Canada is one with a 5-year mortgage term and a 25-year amortization period. Once the amortization period is over, meaning you’ve paid both the home’s full principal and associated interest costs, congratulations! The home is officially yours.
