Mortgage Basics: Amortization
In this blog series we're going to take it back to basics and talk about what role each element of a mortgage plays. Amortization can be a big daunting word, but it's actually a pretty simple concept. It is a derivative of the noun 'amortize' which the Oxford English Dictionary defines as:
"Gradually write off the initial cost of (an asset) over a period"
Essentially it is how long it will take to pay your mortgage off to a zero balance. The amortization period of a mortgage is also one of the most important factors when calculating payments. Generally the longer the amortization period the lower the monthly payment. A $200,000 mortgage at 3% amortized over 20 years will have a monthly payment of $1107.34. Take that same mortgage and move the amortization up to 25 years and your monthly payment drops to $946.49. Since it plays such a large role in calculating payments it also plays a part in determining how much you qualify for.
Since, in simple terms, qualifying for a mortgage has to do with what percentage of your income is being used to cover the cost of the mortgage it follows that the higher you take the amortization the more mortgage money you qualify for. For this reason the government has made changes in recent years to how high that amortization can go. It used to be that you could have a mortgage that was amortized over 40 years! So the payment in the example above would go down to $713.83, that's a huge difference! But honestly is it a good idea for people to be taking on mortgages that will last that long? The Department of Finance decided it wasn't.
So how does the government control amortization periods on a mortgage? Through the Canadian Mortgage and Housing Corporation (CMHC). This is a government controlled organization that provides mortgage default insurance on any mortgage that has a loan to value greater than 80%. Over the last decade CMHC has reduced the allowable amortization on an insured mortgage from 40 years to 25. This means that if you are purchasing a house with 5-19% down you cannot amortize your mortgage over a period longer than 25 years. There are still some lenders who will use a longer amortization but it cannot be insured by CMHC and as such you will most likely have a higher interest rate.