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Wednesday, January 21, 2015

What to look for when choosing my amortization period

By Jonathan Baker

If you are buying a home, chances are that you will also need to talk to somebody about a mortgage. You can get a mortgage through your bank or through a company that specializes and focuses just on mortgages. If you are a first time home buyer, this can be a confusing or intimidating step in the process to getting your new home. 

In a nutshell, the process includes a down payment that you make immediately followed by smaller regular payments to a lender. The down payment will be a large sum of money that is a portion of the total value of the house. A lender will then pay the remaining amount to the seller. Over the following years, you pay back the lender in regular monthly or bi-weekly payments. Since this is a type of loan, you will also be paying some amount of interest on the initial amount of money lent. The amount of time that your payments are spread out over is called the amortization period.

It’s obvious that a higher interest rate will mean that you pay more money and a lower interest rate will mean that you pay less money. However, the choice of amortization period will also make a huge impact on how much you need to pay.

When you have a very long amortization period, the remaining money that you owe has more time to accumulate interest.

Mortgage loan amortization schedules
Longer amortization periods accumulate greater interest costs

When choosing the amortization period that is right for you, you need to look closely at:
  • How much each individual payment will have to be.
  • How much you can afford to pay monthly.
  • How much the total mortgage will cost by the time you finish paying it off.
You will need to weigh different priorities. For example, is it more important for you to pay less overall, or to have to pay less each month?

Short amortization periods

When you have a very short amortization period, your monthly payments will be a lot higher, since you will need to clear the entire amount within fewer years. However, you can save money in the long run since less interest will accrue in that shorter time. If you are thinking about going shorter, you need to make sure that you are prepared:
  • Can you afford the higher monthly payments?
  • Will you still be able to handle both the payments and retirement savings?
  • What are your options if you lose some of your income or have more costs before you finish?

Long amortization period

While this option can cost more in the end, your monthly payment requirements can be much lower. This is a good option for you if:
  • You cannot afford higher monthly payments currently.
  • You anticipate difficulty meeting monthly payments in the future (due to things like medical costs, childcare costs, or loss of income.)
If you start out with a long amortization period, you may also be able to shorten it later by increasing the amount of your payments. Check to see if these kinds of flexible options are available before committing to a plan.

About the author: Jonathan Baker is working as a consultant for finance at Butler Mortgage in Ontario. He keeps himself constantly updated about the latest news and trends in finance world through reading and also shares his insights and about these topics through his blogs. He lives with his wife in Toronto.

 Image license: Royalty Free or iStock source: www.shutterstock.com