Picking the right amortization differs depending on the homebuyer

When I am working with clients on their mortgage approvals, there are several decisions they need to make.

The questions differ a bit based on whether we are working on a purchase, a refinance or a straight renewal. We talk about amortization, term and the specific mortgage product. These questions differ a bit based on what we are doing and the clients’ specific situation.

Amortization refers to the total length of time required to pay your mortgage in full. Term refers to the length of time you choose to lock into a specific rate.

Some of the decisions can be scripted if you are purchasing with less than 20% down and your mortgage requires default insurance. These rules have recently changed (again situation specific) but length of term is up to the individual client.

Historically many people have chosen five-year terms because lenders offer lower rates for that term. Over the last two years, I’ve had far more people opt to pay a slightly higher interest rate and choose a three-year term, gambling that rates will be lower then.

Over the last year specifically as home prices have risen at the same time as the cost of living, I’ve had different conversations with clients about the amortization they choose. With the recent announcement of changes coming to maximum amortizations for new builds and first-time home buyers it will be interesting to see how these discussions change over the next few months.

For clients who were working on refinances or purchases with more than 20% down, we had the option of extending to a 30-year amortization. Some clients are resistant to stretching out the length of their mortgage and for solid reasons. Our parents’ generation was all about getting their mortgages paid off as soon as possible. This is obviously the choice that made the most sense and was more achievable for them and has been ingrained in many of us.

Our current reality is that home prices and the cost of living have skyrocketed, while wages have not kept pace. I’ve heard the argument that our parents were not enjoying a lifestyle that included $6 coffees every day. Fair enough.

However, I have clients who live very frugally and are still struggling. Life happens. Divorce or separation happens. Devastating accidents or illness happen. Childcare bills escalate. Jobs are lost. Stuff happens.

Particularly, when I am working with clients who are consolidating or buying at a significantly higher price point, we have a thorough discussion comparing the difference in monthly payments for (usually) a 25-year amortization versus a 30-year amortization. Signing for a shorter amortization makes better sense for your long-term financial plan. However, if the higher payment causes you stress month after month and you end up in the same boat again a few years down the road, the long-term benefit is not there.

Every lender offers several ways to make extra payments against the principal of your mortgage. Interest rates will likely be different every time you renew your mortgage. Your income and bills change over time.

I will always be an advocate for paying your mortgage off sooner, but many of my conversations with clients are pretty raw about the reality of making your payments every month.

The positive news is interest rates have been trending down over the last month, which will help provide a bit of relief. The better news is by making thoughtful decisions around your choices for amortization and term, you may help reduce your overall stress level.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.