25 Year vs. 40 Year Amortization

Financing your Real Estate Investment

by Dave Peniuk

I bet several of you didn't even know there are 40 year amortization options available to you now. In the U.S. they have had extended amortizations for quite some time, but in Canada the 40 year was introduced recently.

There isn't a simple answer when clients ask me whether extending their mortgage is right for them. It really depends...Here's an example to illustrate:

    * $250,000 mortgage at 5.80%
    * Amortization is 25 years
    * Payments are $1,569.92/month
    * Total interest paid over 25 years = $220,974
    * Amortization is 40 years
    * Payments are $1,328.97/month
    * Total interest paid over 40 years = $387,908.

That is a difference of $166,934 over the life of your mortgage to potentially stretch yourself thinly over a property that is out of your affordability range. And it's going to take you 15 more years to become mortgage free. You also have to realize that because you are paying the principal of the mortgage down slower, you will be building equity in the property at a decreased rate. In fact, for the first 10 years of the mortgage you will have only paid down about one-third as much as in the first 10 years of a 25 year mortgage.

But, before you turn away and decide that option is not for you, there are some advantages of signing up for a longer amortization that are worth considering:

1. If your dream home is just out of your affordability range at 25 years, stretching it out to 40 years may make it affordable
2. You can qualify for a larger mortgage because it lowers your payments
3. If it's a rental property, lower payments will help it produce positive cash flow until rents can be raised
4. If flipping a property, this will reduce your carrying costs until you sell it (this is also a benefit when using interest only mortgages).

It's great to have the flexibility if you need this. But, my caution to clients is that as soon as you can:

• Change your monthly payments to bi-weekly - this will reduce your mortgage length by 3 - 4 years
• Add $50, $100, or $200 to each payment and this will further reduce the length of your mortgage
• Make lump sum payments every year with your tax refund (or other income). Putting that money towards your principal will reduce your amortization by up to 10 years (just check for the maximum allowed without penalty before you do this).

A 40 year amortization may not be for everyone, but as house prices continue to rise it may be an option more and more people will consider. If you arm yourself with the knowledge of how a longer amortization can effect you and you are diligent about paying down the mortgage as I have noted above, owning a home becomes possible for many would-be homeowners and remains a viable option for those wishing to keep their monthly payments smaller.

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