By Nick Holloway - 

When borrowers are assessing their mortgage options with a mortgage professional, one consideration is how long the borrower will need to repay the mortgage loan. This repayment schedule is referred to as an amortization of loan, which spreads the repayment of principal and interest payments over multiple periods until the principal loan amount is reduced to zero. In most instances, mortgages are offered with a 25-year amortization, although this can be made longer or shorter depending on the options available for the specific mortgage product. It is important to differentiate the amortization period from the term of the mortgage, which in Canada is most commonly over a 5 year term, after which time the borrower will be required to renew into a new term or move lenders in order to continue with the amortization of the remaining principal balance.

How are my mortgage payments determined?

The borrower is provided with options to repay the mortgage weekly, bi-weekly or monthly. For ease of example, I will focus on a monthly payment over a 25-year repayment period. Given a 5-year term of the loan, we can determine the borrower will make 60 monthly repayments of principal and interest payments over the period. Assuming an initial principal amount is advanced on the first day of a given month and totals $400,000 with a fixed rate of 3% compounded semi-annually, the first scheduled payment will be due one calendar month following the advancement of the loan, calculated on the principal outstanding amount of $400,000. The payment would total $1,892.98 and is broken down into a principal amount of $899.18 and interest amount of $993.81, which results in a lower principal amount of $399,100.82. For the second monthly payment, the interest component is calculated on this lower principal amount, so while the payment amount of $1,892.98 remains unchanged, the principal amount is increased to $901.41, with the corresponding interest amount reducing by $2.24 to the amount of $991.57. If we fast forward to the 60^th payment at the end of the 5-year term, the proportion paid to principal has increased to $1,040.94, while the interest portion is reduced to $852.04, with an outstanding principal balance of $341,898.42. We can determine in this case that principal has been reduced by $58,101.58, or alternatively by 14.53% from the original $400,000 balance. The interest paid over the corresponding period totals $55,477.34.

What if I were to defer my mortgage payment, what happens then?

If a borrower needs to defer their mortgage payment to manage their immediate cash-flow requirements, this results in no principal and interest payments are applied to the loan balance at the scheduled payment date(s). The interest is still accruing on the loan however, so it should be expected that on the scheduled payment dates, interest continues to be applied to the loan balance in a similar way to a credit card or line of credit balance would, which results in an increase in the principal amount until a time that principal and interest payments are able to be resumed. To refer back to our original example with the balance at $400,000 and assuming the deferral is made at this point, we should expect the new mortgage balance will increase by $993.81 to equal $400,993.81, in effect this is similar to the above amortization schedule but working in reverse. For the following month, the interest on the new balance increases by $2.47 to $996.28, and assuming this is continued for a 6-month period, the new interest totals $6,000 and resulting principal mortgage balance equals $406,000. The borrowers defined benefit is an increase in cash flow of $11,357.88 realized over the 6-month period which they otherwise would have been putting towards their mortgage payments according to my initial example. If we are to capitalize this interest to the mortgage principal, we want to work out the new mortgage amount going forward. If we assume the repayment is calculated over the same 25-year period, the new payment amount equals $1,921.38, or alternatively if this were calculated over a twenty four and a half year basis, the new payment equals $1,947.81. The increases from the original payment amount of $1,892.98 is $28.40 or $54.83 respectively.

What should I do next?

In summary, it is important to understand the costs and benefits of deferring your mortgage. If there is an immediate need to increase cash flow to replace a loss of earnings given the current Covid-19 situation, the flexibility of being able to apply to your lender for a mortgage payment deferral will likely come at a substantially lower interest rate when compared to unsecured borrowing options such as through credit cards or lines of credit. The payment deferral provides temporary relief, and it is with anticipation that earning potential will improve following the initial shock and the economy begins to function normally again once restrictions on physical distancing are able to be lifted. Should there be an opportunity in the future to increase your mortgage repayments to reduce your overall interest costs, this can be achieved by utilizing the pre-payment features offered with your mortgage.