The term of a mortgage is the period of time where the conditions of the mortgage apply, where a borrower will get a certain rate, and where other conditions may apply such as penalties for breaking the mortgage.
The amortization of a mortgage is how long the borrower has to pay back the amount owed, even though this may involve several terms during the life of the mortgage.
With some mortgages, particularly those in the United States, the term of the mortgage and its amortization are the same, with terms extending up to 30 years. Banks prefer shorter terms as this represents less risk to them, borrowers generally prefer longer terms as the risk gets passed on to the bank more, and the market for the most part determines the length of terms offered.
In Canada, for instance, the longest term offered is 10 years, although very few people go beyond 5 year terms due to the significantly increased costs of longer terms than this. The way this all ends up working is that popular choices, such as in this case a 5 year term, become priced more competitively, and with less popular terms, not so much.
The range of terms vary in different countries, with a maximum of 10 years in most countries, with some offering terms up to 15, 20, and 30 years. Only the United States and France offer 30 year terms, so this is the exception. Which term is best for you among what is offered is something that does require consideration.
If most people are demanding a 5 year term, then that’s where the most value will be, and if they demand 10 years or 30 years the most, this is where the market will focus on more.
When looking for a mortgage, we need to take into account not only one rate for a certain term, but compare lenders across other terms. This is not the way people shop for mortgages generally and usually just take the recommendations of the advisor, but often times the advisor doesn’t care much and just wants the sale and will just take the path of least resistance, this is our most popular option so let’s go with it.
There’s much more that goes into selecting the right term for you than how popular it might be though, and when it comes to using this to compare mortgage offers, it makes sense to not just compare rates over a certain term but to look at rate comparisons across different terms as well.
Buying Down the Rate with Points
Generally, the cost of a mortgage will be limited to the interest you will pay based upon your rate, plus legal and appraisal fees. Banks don’t generally compensate borrowers for these fees, but if a lender does help out, this should be taken into account of course.
The mortgage market in the United States is the most competitive and most mature of any country, and one of the additional features that are offered generally is the ability to buy down your rate by what is called paying points.
Paying points makes the most sense on longer terms such as 30 years, and while this involves a larger monthly payment, and the break even point may vary, but is generally less than 10 years. Over the life of the mortgage, over the 30 years in this case, borrowers can realize significant savings by buying points, due to the savings in interest that the lower rates provide.
It is important of course to not add so much to your monthly payment that managing the mortgage will create either an uncomfortable position and especially cause you to pay more interest on your other debt. This is the part that those selling points won’t tell you about, but if you increase your monthly payment by $100 a month, this means $100 a month less to live on, and you very well may be paying much higher rates on the part of this you have out there as debt.
The easiest way to understand this is that if you do have other debt besides your mortgage, and you allocate more toward the mortgage debt and less towards the other debt, this will always result in your paying more interest, since other debt comes with higher rates.
If one carries credit card debt for instance, and expects to in the future, in other words not having a buffer of their own savings to manage future purchases, then buying points is usually a bad idea, and minimizing their mortgage payments needs to be the goal, not adding to them.
Having higher mortgage payments than they could have in the face of other debt is one of the biggest mistakes people make, and the time to manage this properly is when you get your mortgage, not later when you have to refinance to move some of this debt over to the mortgage rate.
If one is looking to buy points with their mortgage, it is wise to carefully think this out, as well as compare costs of buying points among several lenders. The cost of points are far from standardized and shopping around for points is just as important, if not more so, than shopping for rates.
Comparing Mortgage Features
While people don’t tend to focus on what we could consider nice to have features with mortgages, people take advantage of these features more than they might realize when they first get a mortgage, and the time to compare and decide isn’t when you need them but don’t have the ability to take advantage of them.
One of these is the ability to defer payments for one period per year, for instance taking a month off. While some people think that this goes against the intention of paying off your mortgage as soon as possible, only when one does not have any other debt and does not expect to have any, in other words they have significant savings and can devote part of those to the mortgage, that one should even consider paying off your mortgage as quickly as you can to be a goal.
Otherwise, it very often makes sense to take advantage of this option as it is offered, to take a month off from making your mortgage payment once a year. It makes sense to reallocate this payment to pay down higher interest debt, or even to just bank the payment to be used for another purpose later as the need arises.
This will of course add a little to the cost of borrowing of the mortgage, but in any case where you have borrowed other money for other purposes or may expect to, your cost of borrowing overall will be higher if you don’t take advantage of this little vacation from making your mortgage payments.
The ability to make a certain amount of extra payments, to either increase your payment or make lump sum payments, may be an issue with some borrowers, although this doesn’t tend to be anywhere near as big a deal as many think.
The reason is that many borrowers do not realize that in order for this to ever make sense, they have to be both debt free aside from the mortgage and have significant savings as well, enough to cover future needs plus an excess, and it’s the excess that they need to be using on the mortgage.
With many borrowers, this isn’t the case, and often far from the case, so worrying about whether they can pay down 20% of the principal per year without a penalty instead of just 10% is really a moot point when they should not be paying anything extra.
When we take out a mortgage, we never really know how much our income will go up over the years, or how well we’ll end up managing our finances later in life, so it may pay to at least consider these options if one thinks that they might be in a position to benefit from this, but we need to also be realistic here.
Having the ability to have someone else assume the mortgage is a nice to have but something that hardly ever comes up. If you are planning on moving at some point, buying a new house, then being able to port your mortgage can be a big deal and something you really want to make sure that you’re getting good terms with.
Finally, options for refinancing need to be high on everyone’s list, what happens when you need to add more debt on to your mortgage. This is not something you want to learn about when you need it and find out that you either can’t do it or the costs of doing it will be way too high.
Lenders are generally open to such things as it does add to the amount of interest they make on the mortgage, as well as helping their clients get into a better financial position and therefore reduce their risk of default. Contrary to what some people think, banks hate mortgage defaults, as the properties get dumped on the market and the best the bank does is get the principal owing paid back, instead of having an income producing mortgage.
We need to carefully examine and compare refinance options, and refinancing our mortgages is not in any sense a failure, it is actually a wise way to manage our finances, as it makes sense to move debt from a higher rate to a lower one, which is what mortgage refinances do.
Mortgage features do tend to be priced into mortgage rates, and while a lender may be able to offer us a little lower rate, this might be on a bargain basement mortgage with few features and a deal we may come to regret later if we are not diligent enough.