How to Choose the Right Mortgage Term

Feb 24, 2016

Understanding mortgage terms are paramount in choosing the mortgage product that is right for your particular and unique situation.

What is the difference between term and amortization?  Are all terms the same for every lender?  What are the differences of terms from lender to lender?
In order to gain understanding on choosing the right mortgage term, it is important to understand the basics.
Amortization – This is different than “the term” of the mortgage.  Amortization is usually offered in increments of 25 years, 30 years, and even 35 years.  Amortizing a loan is scheduling payments, usually of consistent payment amount, that will pay off the loan in the agreed upon amortization period.  However, in Canada, the lender will agree to loan money to the consumer only for a portion of the amortization period called “the term”.
The Term – Lenders usually offer term contracts for anywhere from month to month up to 10 year terms.  Most commonly, consumers will enter into a 5 year contracted term with the lender.  But on occasion, 4 year, 3 year and even 2 year terms can offer lower interest rates.  In today’s market, where the economy is in a slump, the lower rate terms are attractive to many consumers.  However, in order to qualify for the lower interest rates with lesser years (i.e. 3 year contract) the consumer has to be able to debt service at the Bank of Canada benchmark rate (currently 4.64%).  This means the lender will punch in all the numbers and see if you can afford this same mortgage if the rate was 4.64%.
Debt Service – Debt servicing is what the lender does to determine if your income justifies the mortgage you want as well as takes into account all the debt (and sometimes the credit) you have.  Another name for this is Total Debt Servicing.  Essentially, the lender wants to know if you can afford a mortgage and they have calculations that will determine if you can afford the mortgage.
Credit Score – Credit is another important factor in choosing a mortgage.  The lender always looks at the consumer’s credit history to see if they have managed their credit well.  If your credit score is low due to a life event that was beyond your control and it is a reasonable explanation, the lender will consider your situation.  But that consideration doesn’t always result in a mortgage.  In fact, your credit score is one of the most important aspects of life that only you can manage. If you have poor credit or no credit we recommend that you work on improving your credit rating prior to shopping for a mortgage.
Timing – It’s been said that 70% of mortgages break before the 5 year term is up.  This is an important thing to consider when choosing a term.  If you feel you are going to sell within the next 4 years then it is important to look at 3 year term options.  If you choose a 5 year term and you think you are going to sell in 3 years, you need to realize there are penalties to break a contract term early.
Penalties – Breaking a contract results in penalties.  Early breakage can result in thousands, if not tens of thousands, of dollars.  Depending on whether you are in a variable rate or a fixed rate, the amount of penalty you pay to break a mortgage will certainly keep you up at night.  It’s important to know what the penalty to break your mortgage will be before entering into a contract term.
Clients tend to think that there is an overall best term product on the market.  But there isn’t,  every individual has needs that are unique to their situation.  Claiming there is an ideal mortgage term is like saying the most beautiful colour is blue.  Just like everyone has their favourite colour, everyone has an individual mortgage term that works best for them.

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