Manage your mortgage

Bruce Sellery looks at the pros and cons of picking a long mortgage amortization period.

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Question

I have a $140,000 mortgage at 2.99%. It has an amortization of 29 years, but I have no intention of keeping it that long—I don’t think. So my question is, should I keep the amortization the way it is and make additional payments or should I change it to a shorter period with higher payments? Is there a difference? I can pay up to an additional 10% of my mortgage each year without penalties.

Answer

Yes. There is a difference between these options. Two differences in fact. The first is flexibility and the second is cost. We’ll take a look at both and then you can determine what is best for you.

Flexibility counts for something: But do you need it?

If you keep the payment lower, your amortization will be longer, but then you have the option to make additional payments as you are able. If you set the payments higher, the amortization will be shorter, but you won’t have the flexibility to lower your payment if something happens. If you were to lose your job, for example, would that put your mortgage payment in jeopardy? Or do you have another way to afford your monthly payment—relying on your spouse’s income, or drawing from an emergency fund, for example.

I asked Joe Jacobs for his two cents on your question. He is a mortgage broker with Mortgage Connection in Calgary and he says that based on the mortgage information you provided you can make $14,000 per year in pre-payments. “I would normally suggest keeping the longer amortization and taking advantage of the pre-payment options,” he says. “The reason for this is because if you set the amortization at, say, 15 years, you are forcing yourself to make a higher minimum payment.” If you decide to do this, you can’t go back. Flexibility is key. If you lost your job, then going back to the 29-year amortization payment might give you the few hundred dollars a month in relief you need, he says.

I agree with Jacobs’ viewpoint, but ask yourself this: Do you really, really need the flexibility? One of the best things about having the higher mortgage payment is that it forces you to save. You can’t spend the spare money on things you don’t really need, because the money isn’t there. The lower payment, longer amortization option gives you flexibility, but it will require more from you in terms of self-control. This may be one of your strengths, or you might be like me when it comes to chocolate ice cream: I have no self-control. I cannot have it in the house because I will sneak into the freezer and eat it by the scoopful, directly from the carton, until my belly is bursting or there isn’t one single icy drop left.

Cost goes up the longer mortgage repayment takes.

The second difference between your two options is cost. The faster you pay off your mortgage, the less it costs you. Said another way, the shorter the amortization, the less you pay in interest. For most people, it is a balancing act, keeping up with your mortgage while still having money to actually live your life and save for the future. You want to have as aggressive a mortgage repayment as possible that still allows for some creature comforts and retirement savings.

“Paying off your mortgage is great, but not if you don’t balance it well with savings,” warns Jacobs. “I would rather have a $150,000 mortgage and $150,000 in savings, than a clear title house and no savings. You can’t live off of a clear title house.”

Payments determine amortization, not the other way around.

The key thing to understand, says Jacobs, is that payments determine amortization, not the other way around. So, if you are making extra payments by increasing your regular amount, or by way of a lump sum payment you are in fact lowering your amortization.

He illustrates it this way: “If you have a 29 year amortization, but set payments higher, or make lump sums equal to what a 15 year amortization would be, then you are now in a 15 year amortization, but with the opportunity to go back to the longer period if you desire.

Your mortgage is just one part of a bigger picture.

At the risk of sounding like a snoringly boring disclaimer at the bottom of a bank advertisement, you need to consider your mortgage in the context of your overall financial plan. First, determine what you want in life—both now and in retirement. Then develop a plan to get what you want. That plan includes your mortgage, investing for retirement, and saving for a new car, a trip to Italy or in my case, a sophisticated alarm system for the freezer to keep the ice cream safe.

ask@moneysense.ca

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