The difference between mortgage amortization and term

Q: Could you please explain to me what is the term in a mortgage?

Dear Getting a Mortgage: When you get a mortgage you will have both an amortization and a term. The amortization is the length of time it will take you to pay back the loan. In Canada, the most common amortization period is 25 years. You can amortize your loan for fewer years, which increases your monthly payments but reduces the overall interest you pay. If you have more than 20% equity in the property you may also choose a longer amortization period. This decreases your monthly payments but increases the interest you’ll pay on the loan. The key to remember is that the longer the amortized period the more insurance you will pay.

The term is the period of time you are entering into an agreement with a lender to pay back that amortized loan. The term, then, is a portion of that loan amortization period—consider it the length of time in which you are committing to do business with the lender. For instance, people who really like today’s low rates may lock-in for a five-year fixed term mortgage—but the amortization period could be 25 years. Once those five years are up, you will need to negotiate a new loan and, at this time, you can opt for a new term and a new amortization period.

The term/amortization rule

While amortization periods are typically used to get a better idea of what interest you will pay during the term of a loan it’s also an important benchmark for lenders. That’s because most lenders must use the five-year posted fixed rates on a 25-year amortization (aka: 5/25) to qualify a borrower. Even if you want a three-year variable rate on a 20-year amortization, your lender will still initially qualify you using the 5-year fixed rate and a 25 year amortization (the 5/25 rule). If you don’t qualify for a mortgage based on this rule, you will either be deemed as a b-lender (and don’t get the cheapest mortgage rates), the maximum mortgage you can obtain will be reduced, or be declined for a mortgage by that lender.

Source: Money Sense. by; by   August 24th, 2015

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