Practical Amortization Choices

Rob McLister, CMT, CanadianMortgageTrends.com

Shorter amortizations can cost you less interest and help you pay off your mortgage sooner.

If that’s a revelation to you, then here’s another story you’ll appreciate: Shorter mortgage is money in your pocket.

Since we’re pointing out the obvious, we should also note that making a bigger down payment and buying a cheaper house save interest as well.

This is the type of generic advice that some mortgage commentators like to give while applauding the recent amortization reductions. Few media types have acknowledged that extended amortizations are actually a valuable tool when used intelligently.

It seems that publicly advocating longer amortizations has become semi-taboo, almost like promoting legalized marijuana. But a borrower’s best interests are absolutely not always served by the shortest mortgage.

When choosing an amortization, folks must ask two questions right off the bat:

1. Can I comfortably afford my mortgage if rates rise 3%, and
2. Is there a better use of my cash flow than making larger payments on my mortgage?

If the answers to these questions are both yes, then the longest possible amortization may be appropriate.

In truth, lower amortizations provide net savings only if you have no better alternatives for the money that would have gone towards paying down your principal.

To put it another way, eliminating your mortgage quicker can actually cost you money if:

a) the return on your excess disposable income is greater elsewhere, and/or
b) you have insufficient contingency funds.

Certain types of people need to pay extra attention to the opportunity costs of shorter amortizations. They include:

• Investment property owners (who need to minimize payments to maximize cash flow)
• Self-employed borrowers (who need to reinvest in their business)
• Commission earners (who need to build contingency funds for lean months)
• Investors (who invest in higher-returning assets)
• Families (who need to pad their contingency funds, pay down higher interest debt, top up registered retirement accounts, or build education savings).

So before you jump on a shorter amortization because talking heads say it’s the right thing to do, carefully consider if lower payments would further your financial goals more.