Essential Knowledge Series
Nothing is more important to your finances than your cash flow. Cash flow is potentially the most critical aspect of a person's financial well-being. Not just a person but businesses as well.
In this article, I'll be outlining a way in which you might be able to increase your cash flow using your mortgage amortization. There are no secrets, no tricks, but some solid options for using your amortization to your advantage.
If you're not too familiar with how mortgages work in the first place, click here to learn more about mortgages in general and how amortization factors into your payment.
You might be wondering, what is amortization?
Your mortgage amortization is the length of time it will take for you to pay off your mortgage. In other words, it's a fancy word for the number of years you will have a mortgage payment.
While you can technically pick an amortization of anything more than five years up to a maximum of 30 years in Canada, generally, people will choose between 20 and 30 years. There are two reasons for this. First, and the option that is out of your control is your approval amount. Due to your mortgage qualification numbers, you may have to go with a longer amortization to get approved. The second reason people tend not to go less than 20 years is that if you do, you'll have a much larger payment.
What do I mean by that? See below for a table showing the payment differences from 5 to 30 years for a $500,000 mortgage with a 4% interest rate.
Amortization (Years) | Mortgage Payment (Monthly) |
5 | $9,201 |
10 | $5,054 |
15 | $3,690 |
20 | $3,021 |
25 | $2,630 |
30 | $2,378 |
As you can see, the shorter your amortization, the larger your payment. This makes sense because you are not giving yourself as much time to pay off the loan if you choose a shorter time frame. With that being said, even extending your amortization from 20 years up to 30 years can have a significant impact on your cash flow. In this case, that difference is a total of $643 / month. That's significant. For a family, that extra bit of money each month could be the difference in taking that family trip every year.
"But Alex, it sounds too good to be true. What's the catch?" Like everything in life, there are pros and cons. The first impact increasing your amortization is a longer time-frame with mortgage paymetns. Secondly on the amount of interest you will pay over the life of the loan. Regarding the first issue, not having your mortgage paid off has inherent difficulties because it means you will have a mortgage payment for longer. Regarding the interest portion, this is also a cause for concern. I won't get into specifics on the exact dollar figure difference, but the main point is that you will pay more interest. Logically, this makes sense. Increasing the time and reducing the payment will mean you pay less principal and more interest.
Strategy for Those Looking For Cash Flow Options
Option 1:
If you're reading this and are someone who values cash flow but at the same time wants to pay down their mortgage as quickly as possible, this strategy is for you. To increase your cash flow, start by increasing your amortization from the beginning of your loan or complete a refinance. Increasing the amortization from 20 to 25 years or 25 to 30 years will give you some leeway with your monthly mortgage obligation. However, the key to this strategy is to make sure you can make pre-payments with your current lender.
For example, let's imagine you take a 30-year amortization instead of 25 years, saving you $252 per month. You might use this money for other expenses, invest it or put it in a savings account. If you choose the investment or savings and have built up enough over and above your emergency fund, you can then have the flexibility to use these funds for paying down your mortgage at your discretion. No, you won't pay down your mortgage at the same rate as the lower amortization, but applying a pre-payment will decrease your amortization and save on interest while still reducing your cash flow.
Option 2:
Some of you might be wondering, "If I'm just going to apply this money to the mortgage later on, why wouldn't I leave amortization the same?". An excellent question which brings me to the second significant benefit of this strategy, depending on the lender. Let's imagine the same scenario again from above. If you had gone with the 25-year amortization, you are obligated to make that specific payment. However, some lenders allow you to make an additional payment on top of your regular payment. In other words, if your 25-year payment would have been $2,000 and the 30-year payment, $1,500, you can set up a periodic pre-payment of $500. $1,500 plus your $500 still gives you a total of $2,000, which brings your amortization back to 25 years.
What's the catch? The catch is that you can inform your bank to stop the pre-payment at any time so that you revert back to the $1500. You can't go to your bank with the lower amortization and say, "I want to lower my payment.” With the 30 year strategy, you can. Applying this strategy gives you the peace of mind that if an emergency comes up or you have to cover an expense in the future, you can do that. At the same time, you are paying down your mortgage faster than you would have.
Remember, the key to the second option in this strategy is the lender giving you the ability to make those periodic pre-payments. If they don’t, you're out of luck. Be sure to ask your mortgage professional ahead of time to figure out what lenders in your area have this option.
If this strategy is a bit confusing, that's ok. Contact us using the button below, and we'll help you work through your options.
Remember, “You have as many options as you give yourself.”
Questions/Comments?
Give us a shout in the comment section or find our contact details on the main page of our website at www.triedandtruemortgages.ca
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