It’s a critical decision.
When you’re trying to decide on a fixed, variable or blended rate, one of the central things to consider is term.
Last time out, we learned that amortization refers to the full schedule of payments to erase the debt – the principal for your loan comes down to zero. Depending on your situation, this could take 20, 25 or 30 years. Unfortunately, the lender won’t guarantee today’s low interest rates for that long – this is what determines how much interest you’ll pay for the privilege of borrowing that money.
Instead, lender will give you a shorter term for each contract, agreeing to give you a certain rate for that shorter period of time. The most common length is five years, but it’s possible to negotiate terms of any length between six months and ten years.
So let’s take an example to see what it all means.
A new homebuyer – let’s call her Sandra – went to a mortgage broker in 2010, and negotiated a five-year term with a fixed rate for a 20-year amortization. One piece at a time: 20-year amortization means it will take that long to pay off the loan, so by 2030 Sandra’s house will be paid for. The fixed rate is set for the first five years of that agreement – so in 2015, Sandra will renegotiate a new term.
If the Bank of Canada has pushed prime rates upward, Sandra might have a higher interest rate; either way, she should go back to her mortgage broker to discuss her options for the next five years. Over the course of the mortgage, assuming she doesn’t do anything too financially complex, Sandra will need four 5-year terms before her house is paid for.
If you’d like a somewhat complex picture of what this looks like, check out this doozy: Mortgage Term vs Amortization.
If you’d prefer something simpler, stay tuned for more examples in future posts. In the meantime, why not give us a call? We’ll be happy to sit down with you to help you through the process.
In future blog posts, we will talk about interest (the amount of your payment that goes to the mortgage), principal (the amount of your payment that goes toward the house) and more ten-dollar words, like lien.