People sometimes are confused between the term of a mortgage, the amortization and the rate of a mortgage. I've written this page to explain to you each term and how they all affect your monthly payment.
The Term of your mortgage is the period that you decide to lock in your rate. Typically, people choose either a 1 year term, a 2, 3, 4 or 5 year term. There are 7, 10 and even 25 year term mortgages, meaning you would be locked into that mortgage rate for that period of time. You can also choose a 6 month closed term.
The shorter the amortization, the higher the monthly payment, but you will pay off your mortgage sooner with the shorter amortization. If you choose the right mortgage, you can achieve this very easily, read about how to do this below!
For example, if you borrowed $120,000 and had to pay it off in 5 years (60 months) and even with no interest your payments would be $2000 per month. (120,000/60months=2000/month) The same $120,000 amortized over 25 years would have a payment of $400 per month. (120000/(400months)=400/month) Once you ad interest, the payments are higher, but this shows you why mortgage amortizations are necessary to make the payments more affordable.
Your mortgage rate will depend upon the term of the mortgage that you choose. Generally, the rate you can obtain from your bank will increase if you are willing to commit to a longer term with the bank. The reason is that the banks generally think that interest rates will be higher in 2 or 3 or 5 years in the future, so in order for you to lock in the rate today, you have to pay slightly higher rate for each additional year you add to your mortgage.
For example, current rates are shown in this table. Notice how the interest rate increases for the longer term of the mortgage. Again, the reason for this is that the bank is betting that rates will be higher in the future and in order for them to still make a profit in the future on the money they have loaned you today, they want a higher rate today to offset the "anticipated" future rate increases. It's a gamble by you and by the bank.
As an aside, I almost always highly recommend that you choose short term variable rate for your mortgage, read more about choosing short or long term mortgage.
|Today's Mortgage Rates|
|1 Yr closed||3.20%|
|2 Yr closed||3.04%|
|3 Yr closed||3.23%|
|4 Yr closed||3.32%|
|5 Yr closed||3.41%|
|5 Yr Variable||3.22%|
|See Best Rates|
Your mortgage rate will vary depending upon whether you choose an open, variable or 1 to 5 year term - and this is what affects the actual rate that you will receive from your bank.
Note in the above mortgage interest rate table the variable rate is the least expensive of all the rates. The variable rate mortgage is typically a 1 year variable. This means the term of the mortgage is 1 year. You are locked into the one bank for one year but the rate is variable and will fluctuate based upon the bank prime rate. This is because the bank will give you a low rate today based upon today's mortgage rates (really it's based upon the prime rate) and you are gambling that the interest rates will not increase too much during the term of your variable mortgage. If the prime rate increases .5% during the year you have your variable mortgage, your interest rate will also increase .5%, BUT, you are likely to still have a rate that is less than the rate for a 1 or 2 and for sure a 5 year mortgage. Thus, you are still ahead of the game! This is why I continue to recommend choosing the variable rate for your mortgage.
Assume a $200,000 mortgage is required.
Example 1: Term 1 year variable, amortization of 25 years and using a rate of 2.05% = payment of $851.74
Example 2: Term 3 year fixed, amortization of 25 years and using a rate of 3.31% = payment of $978.59
Example 3: Term 5 year fixed, amortization of 25 years and using a rate of 3.65% = payment of $1014.44
Example 4: Term 1 year variable, amortization of 20 years and using a rate of 2.05% = payment of $1015.68
Notice in example 4, the payment is nearly identical as the 3rd example, but the difference is that if you choose to go with example 4 your amortization is 5 years less. This means that if you were willing to pay the same monthly payment today using a variable rate rather than locking in to the 5 year rate mortgage, you could potentially pay off the exact same mortgage in 5 years less time. This may not sound too appealing today, but trust me, in 20 years when your mortgage is paid off you will have $1000 extra per month for 5 years to spend on whatever you wish! That's also a savings of at least $60,000 Think about it.
You may use the calculator below to do your own calculations and experiment with different terms, amortizations and rate to see how this affect the mortgage balance and your payment, enjoy!
Mortgage Payment and Balance Remaining Calculator
Instructions: Please enter your desired term, payment
frequency, amortization period, mortgage amount and the current interest
Overall average prices.
So, if you are thinking of selling and buying a homes this year, should you buy or sell first? I've had many clients purchase before they sell. I just want you to have all the information so you can make the best decision for yourself and your family. You may read more about buying or selling first here
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I wish you much success, good health and happiness today and always!
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