For any borrower purchasing with 20% or more down payment, or refinancing the home, a 30 year mortgage is an option worth considering. But what exactly are the pros and cons of a 30 year vs. a 25 year (or lower) mortgage in Canada?
Pros of a 30 Year Mortgage in Canada:
Improves purchasing power: A 30 year amortization improves purchasing power by approximately 10% – 15% versus a 25 year amortization, depending on the lender or Bank used. If it means getting into the right house, it could very well be worth it.
Lowers the mortgage payment: Even if you are not maximizing your purchase price, a 30 year mortgage can help to free up extra cash flow for investing, home improvements or simply enjoying life with.
Payments may be increased: By using the prepayment privileges, you could make extra payments to pay down the mortgage faster without any penalty. So it’s not like you’re totally stuck paying off the mortgage over 30 years. By using pre payments you could effectively pay off the mortgage in as little as 5 years (or as much as 30 years) as you see comfortable, or as additional income is available over time.
Offers more flexibility: A 30 year mortgage is also known as an ‘uninsured mortgage’. As opposed to a 25 year mortgage with a slightly lower rate, the uninsured mortgage can be ported (literally moved from one home to another) to a home worth over $1,000,000. In other words, if your home now is worth $750,000 and if in 3 years you decide to buy a home worth over $1,000,000 – then this mortgage would be easily moved/ transferred over to the new home. A 25 year amortization mortgage at a slightly lower rate may not enjoy this flexibility and would need to be broken, with penalty paid and (potentially) lower rate lost.
Cons of a 30 Year Mortgage:
Higher Rate: A 30 year mortgage can definitely have its benefits but these will come at a cost. Usually, the lowest rate 30 year mortgage in Canada will be approximately 0.25% higher in rate than the comparable 25 year amortization mortgage. In other words for every $100,000 in mortgage, the cost will be about $250 more per year on a 30 year amortization vs a 25 year amortization mortgage.
Smaller Payments, More Interest: In addition to a higher rate, the effect of a smaller monthly or bi-weekly payment means it takes that much longer to pay down the mortgage (ie. the idea of a 30 year mortgage) and it means you’ll be paying interest for that much longer. An additional 5 years of mortgage could easily mean $10,000 – $20,000 of more interest – even if the rates were exactly the same as a 25 year amortization mortgage.
May not be necessary: You may not require a 30-year mortgage to buy in the home price range that you are considering. Sometimes a Banker will make a client think this is the only way, when a 25 year lower rate may be possible. Also, the payments are not too much lower with a 30 year. For example, on a $300,000 mortgage, and a constant rate of 2.19% the patent on a 30 year mortgage is $1136.07. The payment on the 25 year version of the mortgage would be $1298.03 or a 161.96 per month difference. If we then consider a lower rate on the 25 year amortization and a savings of $50 per month due to the lower rate, the monthly savings is really only about $100 in this example.
So, especially if you are considering increasing the payment on a 30-year amortization, is it worth paying the higher rate or extra cost for? Is it necessary?
For some, the answer is that it is necessary because it gets them over the finish line and into the right property. Or perhaps the lower payment will be a big help for the next few years. Or perhaps the flexibility of porting the mortgage to a $1,000,000 + home without breaking the mortgage is a big benefit.
Otherwise, if you qualify for a 25-year mortgage and are OK with paying it down a little bit faster in general, the savings definitely add up in favour of the 25 year mortgage.
Connect with Altrua today to see what low rate amortization option may work best for you!