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Should you extend your amortization period to lower your mortgage payments?

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In the wake of rising interest rates and inflation, Canadians are doing what they can to reduce costs. Rising rates have been especially hard on homeowners trying to manage a mortgage.

Some mortgage holders are considering prolonging their amortization period as a way to decrease their monthly mortgage payment. The longer the amortization period, the smaller the monthly mortgage payments will be. But a longer amortization schedule does have its downsides, including paying a lot more interest (and thus a lot more for your home) over the loan’s full term.

Whether or not to extend depends on just how much home you can afford right now.

What is an amortization period?

An amortization period refers to the total number of years during which borrowers make a regular monthly payment to gradually repay their mortgage loan balance, combining both the principal balance and interest owed. This is not to be confused with a mortgage term, which only refers to the length of your current contract.

A homeowner who opts for a short amortization period will have larger monthly payments but will pay less interest over time. Those who choose a longer amortization schedule will reduce their monthly payments, spreading the loan repayment over a more extended period, but this will result in higher interest charges.

The growing number of mortgages with a longer amortization period, including 40-year amortizations in Canada, is worrying both financial experts and the Bank of Canada. Up until late 2021, financial institutions like BMO, RBC, and CIBC had no loan amortization schedules beyond 30 years. Now, all three banks are seeing the percentage of residential mortgages with a mortgage amortization of longer than 30 years rise to upwards of 27%. The popularity of a longer amortization schedule can be directly attributed to homeowners’ efforts to cope with high interest rates by decreasing their monthly payments.

Reasons for extending your amortization period

When it comes to managing mortgage payments and financial priorities, extending the loan amortization period can offer several advantages.

“The primary reason to extend your amortization period is affordability,” says David O’Leary, chartered financial analyst and WealthRocket’s personal finance expert. “Extending the loan amortization period lowers the monthly mortgage payment amount, making it more manageable for individuals with tight budgets. This can be particularly appealing for first-time homebuyers who may be facing other significant expenses.”

Another reason people opt to increase their amortization period, O’Leary says, is to free up funds for other investment opportunities or to pay off higher-interest debt. “Some people might prefer to invest in other assets that could potentially yield higher returns than the interest saved by paying off a mortgage faster,” he notes.

Another reason to extend an amortization period is to help manage risk, which can be especially attractive to someone with an unstable income. For example, a self-employed person may want to go with lower payments so they have a buffer during periods of lower income. Plus, longer amortization periods could make it easier for someone who would normally struggle to get a loan, to qualify for a mortgage. A lengthier amortization reduces the monthly payments and thus leads to more favourable lending ratios.

Pros and cons of a longer amortization period

Extending the amortization period of your mortgage has both pros and cons.

Pros

  • Affordability: The primary benefit of an extended loan amortization schedule is that it can make buying a home more affordable. This is an enticing option for aspiring homeowners who might otherwise struggle to manage higher monthly loan payments.

  • Free up funds: Lower payments means you can allocate more funds to other expenses, or investments.

  • Freedom of choice: You have the option to make extra payments (within your prepayment limit) if and when you’re able to, but the choice is up to you. You can always readjust your amortization period at renewal too.

Cons

  • Higher long-term interest payments: While a longer amortization means lower monthly payments, it also means you’ll pay more interest over the life of your loan. You can calculate the total interest paid on a mortgage of $250,000 over 25 and 30 years using a mortgage calculator at a fixed interest rate of 5.5%, which is an average of the big five banks’ rates at the time of writing. Over 25 years, you’d pay $207,794.00 in interest. Whereas over 30 years, you’d pay $257,516.00.

  • Negative amortization: This can occur when you have a variable interest rate mortgage with a fixed monthly payment. If mortgage rates increase, it’s possible that your monthly payment may not be enough to cover both the interest and principal on your loan amount. If this happens, your interest will increase and your principal loan amount will go up rather than decrease.

  • Less equity: The longer it takes you to pay off your mortgage, the slower you build up equity in your property, which can affect your personal finances and borrowing power.

O’Leary adds that another con of extending your amortization schedule is that you’ll be in debt for a longer period, which could impact other life plans.

How to extend your amortization period

Sometimes, a lender may proactively offer to extend your amortization period. This may happen if you’re struggling to make payments during economic downturns. You would then be presented with the new terms that would include an adjusted monthly payment schedule and the cost of additional interest.

Alternatively, you can reach out to your lender to change your mortgage amortization schedule. You may wish to do so if you are experiencing financial hardships.

Other ways to obtain lower mortgage payments without lengthening your amortization

There are ways to get lower mortgage payments without lengthening your amortization, including:

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Increasing your down payment: If you have the funds, it’s wise to contribute more to a down payment so you can decrease your overall mortgage loan amount.

Choosing a variable-rate mortgage: In a normal interest rate environment, variable-rate mortgages are usually cheaper than fixed-rate mortgages. However, in the current environment, the opposite is true.

Mortgage rates should eventually come down, which means if you switch to a variable-rate mortgage at the right time, you could benefit from riding that decline. “But it’s anyone’s guess as to how long it will take for rates to fall,” says O’Leary.

Downsizing: While not ideal, moving to a smaller, less expensive home can help you lower your monthly mortgage payment.

If you’re still not sure whether to change your amortization length, you should speak with a mortgage broker before making your decision.

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