The mortgage term

The term of mortgage is the period of time a borrower has before the lender can demand the principal balance owing on the loan, subject to mortgage default by the borrower.

Years ago, it was a common practice of lenders to make loans for long periods of time, such as 30 years, at a fixed rate of interest for the entire term.

If amended the long-term, fixed interest mortgage to one that would allow an adjustment of interest to periods of from one to five years, it would attract more mortgage money.

The amendment was made and other lenders fell in line. With the exception of banks and other large lenders doing business with favored customers, and some private lending, mortgages with a term of more than five years became scarce. Seven-year and ten-year terms have surfaced.

Trust and mortgage loan companies are offering a prime rate of interest to the public for investing in five-year certificates and debentures. The trust and mortgage loan firms use the money for mortgage investments at about 2% increase to the mortgagor. The term of such loans must obviously match the term of the certificates -five years.

If you were the borrower with a repayment schedule amortizing a loan over a period of 20 years, and the mortgage had a five-year term, it would mean that despite the 20-year amortization, you would have to repay the outstanding principal balance of the loan at the end of the five years.

Take a look at the following table in a $20,000 loan, 9 1/2%, compounded semi-annually, amortized over 20 years.

Principal balance owing at end of:

Year   1 - $19,640

Year   2 - $19,240

Year   3 - $18,820

Year   4 - $18,340

Year   5 - $17,820

Year   6 - $17,240

Year   7 - $16,620

Year   8 - $15,920

Year   9 - $15,160

Year 10 - $14,340

Year 11 - $13,420

Year 12 - $12,420

Year 13 - $11,320

Year 14 - $10,120

Year 15 -   $8,800

Year 16 -   $7,360

Year 17 -   $5,760

Year 18 -   $4,020

Year 19 -   $2,100

Year 20 -     $0.00

You will notice that in 20 years the loan will be extinguished, but here is where the five-year term will grab you.

At the end of the five years, the lender wants his money, namely $17,820. To repay the loan, you probably will have to commit yourself to another mortgage, and borrow the rounded balance of $17,800. If you commit yourself for a further five-year period (same amortization and rate) this is what your outstanding balance will be over the next five years in round figures:

Year 1 - $17,479

Year 2 - $17,123

Year 3 - $16,749

Year 4 - $16,322

Year 5 - $15,859

At the end of this five-year period, when you have to repay the loan, you may repeat the process. We'll do this just twice more, to take us to the end of four five-year terms.

Third five years: ($15,800 loan)

Year 1 - $15,515

Year 2 - $15,199

Year 3 - $14,867

Year 4 - $14,488

Year 5 - $14,077

 

Fourth five years: ($14,000 loan)

Year 1 - $13,748

Year 2 - $13,468

Year 3 - $13,174

Year 4 - $12,838

Year 5 - $12,474

Each new five-year term will result in smaller monthly payments because the principal amount of each succeeding term will be less.

If one keeps up the pattern of the five-year terms by starting each new term with the outstanding principal balance of the previous one, and amortizing the loan over 20 years, it will never reach zero.

Whereas if the term of the mortgage had been 20 years, it would have been reduced to zero in that time, although the monthly payments would have remained constant (and larger) than under each renewed five-year term.

If the 20-year mortgage is to be retired, or paid in full in 20 years, then each time the mortgage is renewed, the principal balance owing must be amortized for no longer than a period than the remaining number of years in the original amortization.

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