Amortization Can Change your Cash Flow
Amortization can change your cash flow. Amortization can be your best friend in times of Inflation and higher rates. If your downpayment is less than 20%, the longest amortization you’re allowed is 25 years. However if you have more than a 20% downpayment or equity in your home, you have the option of a 30 or even some lenders are offering a 35 year amortization.
Adjusting how long it takes you to pay off your mortgage may save you from falling into the debt loop
The amortization period is the length of time it takes to pay off a mortgage in full. Lengthening the amortization decreases the monthly payment. Let’s look at a $650,000 mortgage and see how amortization effects monthly payments.
$650,000 @ 4% interest rate amortized over 25 years = $3419/month
$650,000 @ 4% interest rate amortized over 30 years = $3090/month
$650,000 @ 4% interest rate amortized over 35 years = $2865/month
Why would you want to choose a longer amortization? Why take longer to pay off a debt. Well the answer is in your overall debt servicing ratio that we discussed previously. That is the ratio that calculates your personal income to debt. If that ratio is high, over 35%, meaning you have high debt levels to income, then increasing your amortization may increase your disposable income and prevent you from incurring other high interest rate debts, may allow you to pay off debts fully and even contribute to retirement - such as RRSP’s. Manage inflation and higher costs of living without creating credit card debts etc.
You may only need to use a longer amortization that provides a lower monthly payment for a short period. For example the rapid rise of inflation and cost of living we are currently experiencing, or a temporary change in income, raising children, health issues. Your mortgage contract will stipulate the minimum payment you owe based on the preset amortization set out in your mortgage contract. However most mortgages have a feature that will specify pre-payment privileges, you can use these to increase your monthly payment when you can and or make lump sum payments to your mortgage. Both increasing your monthly payment and or making a lump sum will decrease your amortization so that you can reach your goal of paying off your mortgage when you want.
The key is to have the contract initially set up in your favour. Meaning you have the longest amount of time to pay off your debt and shorten that by increasing payments as you can.
The alternative usually happens, you stipulate a shorter period of time with your original contract say 18 years and once this is in place you can not change it and it will dictate your minimum monthly payment which may be higher than you can afford.
Having higher payments than you can afford, with a shorter amortization can increase high interest debts which may put you into a debt loop that is very hard to get out of and makes the banks money but may cost you.
If your mortgage is renewing and you are afraid of higher interest rates, call and discuss changing the amortization to suit your financial needs. If you currently have high interest rate debts consider refinancing into a mortgage with a longer amortization so that all of the debt is a lower rate and you are managing it with monthly payments. Take the time to get detailed advise to see what your options are.
Mortgages are not just rates they are financial instruments that can be used to create cashflow and save you from debts. Call me to discuss your options in detail. Your mortgage may be the solution.