How amortization works
A mortgage is an amortized loan, or one where you make a scheduled payment (typically each month) and this payment is applied to both the principal of the loan and the interest that accrues. The payment goes to the interest first, and anything remaining goes towards the principal. This can mean that a smaller monthly payment will see you paying mostly interest, rather than paying down your principal.
To demonstrate the difference between a 15-year mortgage and a 30-year, let’s take this example.
Say you have a $700,000 mortgage on your home and you’ve put 20% down, or $140,000. At a 7% mortgage rate, if you choose a 15-year term, you will pay $6,252.75 per month and your interest payments over the life of the loan will be $230,757.76.
By contrast, on a 30-year mortgage, your monthly payments will be $4,610.22 and you will pay $406,625.99 in interest. In other words, the extra 15 years will cost you an additional $175,868.23. That’s a quarter of the value of your home, and a serious amount of cash that could be put towards your retirement savings, your child’s education or making improvements to your home.
Ramsey advised his readers to create their own amortization schedule to ensure they have a clear view of how a long mortgage could see them throwing money away.
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Get StartedRamsey’s tips for mortgages
Of course, affordability is a top issue for Canadians, and 30-year mortgages are common because it can be difficult to find the extra funds for a large mortgage payment each month.
In addition to recommending a shorter loan term, Ramsey offered a few more tips for getting the best mortgage for you. Here are his words of advice — plus a few more of our own.
1. Shop around Doing your homework by comparing several different lenders could lead you to a better mortgage rate or amortization schedule for your loan. Don’t feel like you have to go with your existing bank or one that’s recommended to you. If you have time to explore your options, do so as much as you can.
2. Start early If you’re shopping for a new home, preapproval for a mortgage can help you to move faster when putting in an offer. This process can also be lengthy. From start to finish, the mortgage approval process can take a few days or up to a month or more, which is mostly dependent on the complexities of the transaction.
3. Be prepared (and prepared to wait) Your lender will review your credit history, income and current debts in the process of evaluating you for a mortgage. You may also be expected to foot the bill for appraisals, property inspections, survey fees, title searches and lender reviews.
Do your research ahead of time to understand what will be required, how much it will cost and the timeline for each step of the process. This can help you manage your stress while you shop for a new home.
4. Make additional payments If you have an existing mortgage, or will have to sign for a 30-year term, do your best to budget for additional payments on your loan. If you can make an extra monthly payment, these typically go towards your loan principal, not the interest. Every extra dollar helps and can help you chip away at your balance and pay off your mortgage faster.
5. Refinance your existing mortgage Finally, Ramsey suggests that existing mortgage holders could look at refinancing their loans to reduce the term.
“This would change things like your interest rate, monthly payment amount and amortization period,” he wrote.
Again, this is a place to shop around and take your time. Look for a lower interest rate and a shorter amortization period, while keeping the monthly payment amounts realistic. If you’ve managed to increase your salary or reduce your debt and expenses since your initial loan agreement, a refinance is a smart move to get you even closer to total debt freedom.
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