Amortization vs Term
Applying for a mortgage can at times be confusing in itself due to the terminology. Two of the terms that can often be interchanged are Term and Amortization.
Amortization
The amortization of the mortgage refers to the number of years you are allotted to pay back the mortgage in full. For example, if your initial mortgage amortization is 30 years, you are allowed 30 years to pay back the mortgage in full.
Term
The term of the mortgage refers to the number of the years the interest rate is applicable for. For example, if you have a 5 year fixed mortgage at an interest rate of 4.15%, the interest rate of the mortgage will be 4.15% for five years. After the 5 year term, the mortgage is up for negotiation again so a brand new interest rate is set at that time.
Length of a Term
The term of the mortgage refers to the number of the years the interest rate is applicable for. For example, if you have a 5 year fixed mortgage at an interest rate of 4.15%, the interest rate of the mortgage will be 4.15% for five years. After the 5 year term, the mortgage is up for negotiation again so a brand new interest rate is set at that time.
Most terms can range from 6 months to 10 years. The reason why you would choose a shorter term would be because you think you will be selling the property in the near future or because you believe that interest rates are going down. A person would take a longer term for the exact opposite reason – they don’t believe they will be selling the property anytime soon or because they believe interest rates are on the rise. By locking your mortgage into, for example, a 10 year fixed term, you know exactly what the interest rate and mortgage payments are going to be for the next 10 years.
Think Carefully About Your Term
So, why is it important to think carefully about the term? If the mortgage is in a fixed closed term, and if you were to break out of the mortgage before the stated term, in most cases an interest penalty will apply. When you get a mortgage with a lender for a stated term, the lender is counting on that money being locked for that stated term. If you were to break out of the mortgage early (due to selling your home, paying out the mortgage, or transferring the mortgage to another institution), the bank will penalize you for breaking out of the contract early. Standard penalty amounts are either 3 months interest or the IRD (Interest Rate Differential). Other lenders can stipulate that payout of the mortgage is not allowed or that full interest will be charged.
Mortgages that are “open” don’t charge a penalty upon payout. For example, a 5 year open mortgage means that the mortgage can be paid out at any time without payout penalties. During the 5 year open term, the interest rate will stay the same however, in most cases the interest rates for open mortgage will be higher than that of fixed mortgages. Lines of credits are also a credit facility that is fully open in the sense that no penalty applies upon payout of the mortgage.