This is the 9th article in our Mortgage Life Cycle Costs series.
As a reminder, Canada’s large banks are a saturated oligopoly. Oligopolists are interdependent of each other and usually don’t risk competing by price [interest rates], instead they compete by image, retention, etc. Consequently, in our Mortgage Life Cycle Costs series, we caution you that an over-focus on interest rates [price] may blind you to other important mortgage factors that can cost you a lot more than the difference between two mortgage interest rates.
Why write these articles? We have seen many people suffer loss, because of an over-focus on interest rates. We believe you can make better mortgage choices when you know and understand critical information about mortgages.
In this article we will cover the mortgage amortization. You may be wondering why spend an entire article on the mortgage amortization? Precisely because the mortgage amortization is so inconspicuous, borrowers misunderstand and often neglect to apply its great mortgage planning characteristics. A good mortgage amortization strategy can protect you and help you to become mortgage free faster while an unmanaged amortization period can be very limiting. To make it worse, the undesirable consequences of an unsuitable amortization period are usually only discovered at the time of need when very little can be done to correct the problem without cost.
Let’s explore your mortgage’s amortization period.
Before we continue let’s first define the amortization period. In Canada the amortization period is different from the mortgage term. The distinction is very important, because some countries give the mortgage term and amortization the same meaning, but in Canada the term and amortization period refer to two very different mortgage variables. The mortgage term is the length of time your mortgage agreement and interest rate will be in effect. Please click here to read more about the mortgage term.
According to the Merriam-Webster dictionary the applicable definition of amortize is: to pay off an obligation gradually usually by periodic payments of principal and interest. This means a mortgage’s contractual amortization period is: the length of time it would take to pay off a mortgage in full, based on minimum mandatory payments at a certain interest rate.
From the amortization period definition, we can glean important information about your mortgage amortization and clues for use in mortgage strategies:
- Interest-Only Loans: Because interest-only loans e.g. Home Equity Lines of Credit [HELOCs] usually don’t have a minimum mandatory principal and interest payment, these loans consequently don’t have an end date and thus also no amortization period.
E.g. Although we may colloquially also refer to HELOCs as “mortgages”, HELOCs are secured loans [secured against real estate], and not mortgages.
- Relationships Between Mortgage Variables: A mortgage’s amortization period, payments, interest rate, interest rate compounding and loan balance are all connected in mortgage formulae. This means if one variable is changed some of the mentioned variables will also change.
E.g. all things else being equal, the amortization period is shortened with increased payments and/or a reduction in the mortgage balance and vice versa.
- Interest vs Principal: All things being equal, for each consecutive mortgage payment the interest portion decreases, and the principal portion increases exponentially as the mortgage progresses down its amortization schedule on its way to being paid off in full.
- Blended Mortgage Payments: Most Canadian mortgages have blended payments. Blended mortgage payments have set principal and interest [blended] payments over an agreed-upon contractual amortization period. Thus, while the principal and interest portions inside the mortgage payment may change, the minimum mandatory mortgage payments remain the same over time and the amortization reduces as the loan is being paid off.
E.g. If you make a substantial lumpsum prepayment against your mortgage the amortization period will reduce appropriately, but your minimum mandatory payment should remain the same as before.
Note: While blended mortgage payments offer predictable budgeting, the borrower pays more interest compared to fixed principal mortgage payments.
A mortgage usually has three amortization periods: a qualification, contractual and the actual amortization period. What they are and the differences between them are essential knowledge to mortgage eligibility, strategies and mortgage pitfall avoidance.
- Qualification Amortization Period: Your lender uses this amortization period to determine your maximum mortgage eligibility. Subject to the mortgage/loan type, the qualification amortization period can be <= contractual amortization period, but not more [longer]. In most cases the qualification amortization period is equal to the contractual amortization period, however, for complex mortgage products such as HELOCs and mortgage products that include a HELOC, the qualification amortization period may be less [shorter] than the contractual amortization period to limit the borrower’s maximum mortgage eligibility.
E.g. The maximum overall qualification amortization period for a mortgage/HELOC combined loan may be 25 years even though the maximum contractual amortization period of the mortgage component itself could be 30 years.
- Contractual Amortization Period: Your mortgage’s contractual amortization period is usually stated on your lender’s original mortgage commitment. The contractual amortization period usually determines the mortgage’s regular, minimum mandatory payment. A mortgage’s contractual and actual amortization periods are usually equal on the mortgage closing date.
- Actual Amortization Period: All things being equal, a mortgage’s actual amortization period usually remains equal to its contractual amortization period if the borrower makes no additional payments. However, the actual amortization period usually reduces to less [shorter] than the contractual amortization period when a borrower pays down their mortgage balance by utilizing their mortgage privileges.
E.g. Making lumpsum prepayment[s] and/or increasing the mortgage’s regular mortgage payments to exceed the mortgage’s minimum mandatory payments.
Note: Your lender’s mortgage statements during the mortgage term and its mortgage renewal offer usually state your mortgage’s actual amortization period, not its contractual amortization period.
Note: Mortgage rules and lender guidelines usually prohibit the remaining actual amortization period from exceeding the mortgage’s remaining contractual amortization period.
Because a mortgage’s amortization period determines the time to pay off the mortgage in full, it also determines a borrower’s maximum mortgage eligibility and indebtedness. Hence, it should be no surprise that the government not only directly regulates maximum amortization periods for various types of mortgages, but also use mortgage amortizations to indirectly control the Canadian housing market. Here is a brief summary of maximum amortization mortgage rules as of this writing:
- Down Payment < 20% [Insured]: Qualification <= 25 Years | Contractual <= 25 Years
- Down Payment >= 20% [Convectional-Insurable]: Qualification <= 25 Years | Contractual <= 25 Years
- Down Payment >= 20% [Conventional-Uninsurable]: Qualification <= 30 Years | Contractual <= 30 Years
- Down Payment >= 20% [Conventional-Uninsurable/Loan includes interest-only component]: Qualification <= 25 Years | Contractual <= 30 Years
- Down Payment >= 20% [Conventional-Uninsurable/100% HELOC]: Qualification <= 25 Years | Contractual: N/A
Note: While isolated prime lenders and alternate lenders may still offer 35-year or 40-year amortization periods respectively, the vast majority of prime lenders limit their maximum conventional mortgage amortization periods to 30 years.
Note: In Canada the 25-year amortization period is deemed to be the standard and longer or shorter amortization periods are deemed to be riskier by mortgage regulators.
A mortgage’s amortization period can be its easiest, but highest impact planning tool, yet it is probably also its least utilized. Before we start to look at specific amortization strategies, let me first make a few important points:
- Mortgage Terms & Conditions: Using your mortgage amortization period as a planning tool is subject to your mortgage terms and conditions. If your mortgage’s terms, privileges, etc. are incompatible with what I discuss in this article, your mortgage may be ineligible for these strategies. Please check with your lender before attempting or proceeding with any of these strategies.
- Your Mortgage Broker: The strategies we will discuss are usually most successful if your mortgage broker can assist you with the execution. Note: Not all lenders truly partner with mortgage brokers to help their mutual clients and I make no bones about my reluctance to place mortgages with lenders that prohibit me from assisting my clients when they need my help. As a client it can be very frustrating if you cannot get support from your lender and your broker is disallowed from serving you, so these situations are best avoided.
Let’s revisit and develop some of the earlier amortization information into useable mortgage amortization planning strategies:
- Contractual Amortization Period Calculation: As I mentioned above, once you reduce your mortgage’s balance [all other things being equal], its actual amortization will be different and less than its contractual amortization. While your lender’s statements usually indicate the mortgage’s remaining actual amortization period, they typically omit the remaining contractual amortization period. Because the contractual amortization period is important for planning purposes you should contact your lender to obtain it, but this is how the remaining contractual amortization is usually calculated:
Present [Remaining] Contractual Amortization Period = Original [on the closing date] Contractual Amortization – Time Elapsed since the Closing Date.
Contractual amortization on the closing date: 25 Years [300 months].
Time elapsed since the closing date: 27 months.
Remaining actual amortization period after 27 months: 257 months.
Calculate the remaining contractual amortization:
Remaining Contractual Amortization Period: 300 Months – 27 Months = 273 Months [22 Years, 9 Months]
Remaining Actual Amortization Period: 257 Months [21 Years, 5 Months]
- Reducing Mortgage Payments: If you have voluntarily reduced your mortgage balance by making additional or increased payments, etc. a suitable mortgage’s terms and conditions should allow you to return your mortgage’s remaining actual amortization period to its remaining contractual amortization period. Doing this should also reduce your regular, minimum mandatory mortgage payments to match the mortgage’s remaining contractual amortization period.
Specific Mortgage Amortization Planning Examples:
- Mortgage Rules: Your contractual amortization period may determine and/or affect your mortgage eligibility, available mortgage products, future interest rates, etc.
E.g. A principal residence purchased for less than $1M with a down payment >= 20%: You may be eligible for a 30 year amortization period, but a 30-year amortization will cause the mortgage to be uninsurable, which could subject you to higher interest rates both for the present and subsequent mortgages.
E.g. A principal residence purchased for more than $1M: Mortgages for properties purchased for $1M or more are deemed to be uninsurable irrespective of the mortgage balance or amortization period. Thus, there are no rate benefits associated with a lower amortization period.
- Protection: Subject to your circumstances and all things being equal you could request your mortgage to be approved at a higher contractual amortization period and thus consequently reduced regular, minimum mandatory mortgage payments. Then, once your mortgage has closed you could voluntarily make additional mortgage payments to reduce your mortgage’s actual amortization to your desired actual amortization period. How could this strategy protect you? You should be able to reduce your regular mortgage payments to their remaining contractual amortization period, minimum mandatory payments during financial emergencies.
E.g. A growing family anticipates reducing their household income to a single income during parental leave. They could have their mortgage approved at a 30-year amortization period, then make 25-year amortization equivalent payments right after their mortgage closing date. Upon their reduced household income, they should be able to lower their mortgage payments to the remaining contractual amortization period, payments, etc.
- Mortgage Renewals, Transfers, Switches, Ports, etc.: These transaction types are subject to strict regulations, so their maximum eligible amortization period is usually limited to either the greater of the remaining contractual or actual amortization period. Depending on your circumstances, etc. you may want to choose their remaining contractual amortization period to protect yourself as explained above and because a shorter remaining actual amortization may severely limit your future mortgage options and/or cause you financial hardship.
Note: Choose carefully, because your existing mortgage’s amortization period you choose for your new mortgage, becomes the new mortgage’s maximum contractual amortization period on the closing date.
Note: Most lenders will only offer borrowers the remaining actual amortization period for these transactions, even though the remaining contractual amortization period may be available. Thus, be sure to request the mortgage’s remaining contractual amortization period and associated minimum payments from your lender if you need it.
E.g. On its renewal date a mortgage’s remaining actual amortization period is 10 years and its remaining contractual amortization is 20 years. The borrowers feel optimistic and choose the 10-year remaining actual amortization period for their new mortgage. However, 2 years later they decide to sell their home and wish to port their mortgage to a larger home. Because their maximum contractual amortization period cannot exceed 8 years [10 Years – 2 Years = 8 Years], they don’t qualify for the mortgage port and they are obligated to break the existing, low-rate mortgage and incur mortgage penalties just to extend their amortization period so that they can be eligible for their new mortgage.
As you can see your mortgage amortization period can be great tool to help protect yourself against financial emergencies, pay down your mortgage faster, etc., but all these strategies depend on a good and suitable mortgage. Let us help you with such a mortgage.
- The opinions expressed in this article are the opinions of the author only and not of anyone or any other entity.
- Not legal, economic, financial or any other advice.
- Not for decision-making purposes.
- Subject to eligibility, lender approval and terms & conditions
- In any and all cases of any conflict of any kind about anything whatsoever, lender rules, guidelines, terms & conditions, interest rates, etc., supersede the presented information.
- Subject to change in any or all ways, at any time, without prior notification or warning.
- Does not include all, may exclude some and/or may only partially represent guidelines, mortgage rules, scenarios, topics, etc.
- These are general guidelines and are not specific to any particular mortgage lender or mortgage related product. Lenders don’t all have the same products, underwriting guidelines, etc.
- Subject to all borrowers seeking independent professional advice from any and all providers as determined solely by the borrower, at the borrower’s own and sole discretion, prior to applying for or making changes to a mortgage/loan.