One the surface, it sounds great when you hear that a residential mortgage can be amortized for over 30 years, providing you with a means to reduce your monthly cash flow outlay.
But when you break down the numbers, is the decision to take on a longer term amortization a good one?
For instance, if you take any mortgage amount and compare 15, 20, and 25 year amortization periods, you will find that moving from 15 years to 20 years or 25 years will reduce your monthly payment by 20% and 31% respectively, versus what the payment would be for a 15 year amortization. But looking at the numbers further, the total interest cost paid over the life of the mortgage also increases by 36% and 74% respectively versus the 15 year am.
So the question is does the reduced cash flow benefit offset the total increase interest? If you plan to pay the minimum on your mortgage for the full amortization term, the longer amortization period does not make a great deal of economic sense for you if you have the ability to cash flow a higher payment. Obviously if you do not have the cash and that extra couple hundred dollars a month is the difference of making your cash flow work or not, then the longer amortization may become a necessary evil.
The other situation where a longer term amortization makes sense is where you know, or are pretty sure, that you’re going to be able to put incremental lump sum payments against your mortgage over time. Most residential mortgages now a days have some sort of annual prepayment you can make without penalty. Especially in situations of self employment where the income earned can be seasonal or more erratic, the longer amortization provides the least possible monthly payment and prepayment options allow you to pay down the mortgage faster so you aren’t paying all that additional interest associated with a longer amortization period.
Consider longer term amortizations as a tool and use them to maximize your cash flow. At the same time, make sure you understand the cash flow and interest trade offs as well as over time the longer amortization can cost you a significant amount of money.
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I'm a Toronto Mortgage Broker that arranges mortgage solutions on residential and commercial real estate property. With over 30 years of mortgage financing experience, I'm able to quickly assess your financing requirements and provide relevant solutions for your immediate consideration. Joe Walsh Google+ YouTube Channel