Nobody likes reading the fine print. Loan terms are thought of in terms of time. How many years will I be paying this down? When can I breathe a sigh of relief? But, from a lender’s perspective, it’s about payment amounts, interest rates, amortization schedules, and how much headache you might represent over the next (insert loan years here). This disconnect in understanding represents the biggest reason that borrowers and lenders are not on the same page when they meet to hash out terms for a loan.
What Are the Terms of a Loan? (Time Vs Payments, and Why Mixing Them Up Sucks)
The most common mistake borrowers make is how they understand the word “term” as in “how long until I’m free from this obligation?” Lenders, on the other hand, connect the word “term” with “when do we need to meet again to renegotiate the rate on this loan?” There’s clearly a difference between the two interpretations of the word “term,” and that confusion is a real source of financial pain.
As a borrower, it’s helpful to think of the length of your loan as the “amortization period.” This represents the total amount of time it will take to pay off your loan completely. If we look at a residential mortgage, for example, this is currently around 25 years. Compare that to a small commercial loan, it is usually less than 20 years. So, even if the properties cost the same up front, the payment amounts will be much different because of time. So will the amortization period, the interest rates, and the principal. But what confuses some borrowers is that, in Canada, many loans have a term that is shorter than the amortization. Like, you may have a 25-year amortization but a 5-year term. And because of this, your payment is calculated as if you have 25 years to pay it off, but you still have to renew or renegotiate the interest rate after 5 years, and this means your payments might go up or down based on what rates are doing at the time you renew. Without proper understanding and planning, you could price yourself out of a loan you could afford only a few years earlier. We see it all the time with other lenders, and that’s because the borrower isn’t given all the information to plan accordingly for market volatility.
On the broker side of this equation, it’s an opportunity to add real value to the borrower. Knowing that the client is potentially planning around a 5-year term thinking the loan is paid off in that time, you can proactively let them know the whole road map of the loan and make sure they are prepared to prepare properly. Don’t assume, but walk them through the difference between amortization and term up front. Use a whiteboard if you have to and send a photo of the process for their records (and to protect you down the line). And watch out for those commercial clients who want balloon payments or shorter terms. A 3-year term on a 20 year amortization means a giant payment at the end of year 3 unless they refinance the loan.
You don’t want to see anyone stuck on payments and you definitely don’t want that kind of hit on your reputation as a broker. Simply ask the question “What happens at the end of the term?” and if they um and ah, you know you need to get out that dry erase. This is how you safeguard your reputation for the long term, versus explaining in 3 years why they still owe almost the entire principal. We find most people still follow through on loans, even when there is what seems like more moving parts up front, because mapping out everything builds trust and risk gets built into expectations.
What Are the Most Common Loan Terms? (And Why Does Everyone Keep Picking the Same Ones?)
Why does everyone select a 2, 3 or 5 year loan term? Why are these the standard? When it comes to mortgages, everyone loves a 5-year term. It’s the vanilla ice cream of loans. Safe, simple, a nice sounding number. Let’s discuss why this is the case, and why you should actually pick a different number.
As a borrower, a 5-year term is most common because it’s a balance of stability and flexibility. Most people can plan for 5 years in their life. “Where will I be in 5 years?” doesn’t feel daunting. And the interest rates for a 5-year fixed mortgage are usually quite reasonable, especially if rates go down in the near future. You also don’t have to revisit your mortgage so frequently that you start planning your vacation around it.
A 3-year term is popular if the borrower anticipates a rate drop might happen soon. Lower interest rates are great, and locking into lower payments for a fixed period is an opportunity you don’t want to miss. Sure, you will pay a higher rate for renewing sooner, but the possibility is tantalizing enough.
And 2-year terms are for gamblers or for people who know they are selling the property soon, aka house flippers.
That’s for fixed. Variable rate terms mean a floating interest rate that goes up and down with the Bank of Canada rate. They are usually 5-year terms, and are for people with a good risk tolerance, as your monthly payments will definitely be a bit of a roller coaster. These borrowers do really well when the rates are low while others are locked in a higher interest rates on fixed term loans, but the opposite is also true, so it takes a strong stomach or a chunk of change in the bank just in case. When we mentioned “balloon payments” earlier, that is when the lender wants to reduce their risk. Using the example of a commercial loan, that might mean that the first 5-year term is actually the full loan, not just the first chunk, so read your commitment letter carefully!
Message to brokers: just because your client defaults to 5 years (based on what their parents did or what their friends recommend), your job is to ask thorough questions to customize the right loan for them. Are rates expected to go up or down? Are you planning to sell in two years? Is this a long term hold or a quick flip?
If the borrower plans to live in the house for 20 years, a 5-year fixed term is fine. That’s why your parents recommended it. But if the borrower is a commercial investor and the plan is to renovate the property and refinance it in 18 months, a 5-year term with a prepayment penalty is the equivalent of financial self harm. What penalty for pre-payment they ask? In Canada, that penalty can be the greater of 3 months’ interest or an interest rate differential, which on a large loan can be thousands. Sure, you as the lender know the difference. But making sure your borrower also knows the difference is you earn your commission, and build a rep that surpasses all the other loan brokers in the land.
The 5 Types of Loans: Mortgage, Working Capital, Auto, School, and Personal
Every loan is different, and by the time they’ve read this article, they’ve already had at least one of the five most common types. But every type of loan in this elite group of loans is very different from the next, and knowing that is powerful knowledge.
- Mortgages = secured by real estate. If you stop payments, the lender gets your property. High stakes are the cost of lower interest rates.
- Seed or Working Capital for Small Businesses = used to buy inventory, cover payroll, or launch a product. Because there is no property for collateral, they are harder to get approved for.
- Automotive Loans = secured by the car or truck that you are borrowing against. Interest rates are all over the map based on things like whether it’s new or used, and if your credit score looks like a Matisse or a Picasso.
- School Loans = usually through OSAP so lower rates and super flexible payments. Private school loans do happen, but are super unforgiving, so buyer (borrower) beware.
- Personal Loans = unsecured, no collateral, i.e. really expensive. Interest rates can make credit card companies blush, and should be avoided unless you have a solid repayment plan and guaranteed income. Break glass only in case of fire, basically.
Brokers can guide their clients by explaining all the types of loans and recommending the right loan for the right purpose. Using a personal loan to fund business working capital as you go from your garage business to an office space is dumb, sorry. Similarly, using part of your mortgage to pay off credit cards might look good on paper, but encourages bad habits that can bite you in the future. And, for the love of underwriting, do not let your client take out a car loan two weeks before closing on a mortgage. That new monthly payment will wreck their debt ratios and potentially kill the deal at the eleventh hour.
Also, know your lenders and their specialized offerings. Glasslake focuses on filling the gap for Canadians who have difficulty qualifying through traditional banks — particularly the self-employed and real estate investors. We are not the right fit for a $15,000 personal loan, so please don’t ask. Matching the client to the right loan is half your job, and half your commission. The other half is keeping them from making bad decisions.
What Is the Monthly Payment of a $50k Loan? (A Fresh Example So We Are Not Repeating Ourselves)
Let’s say you want $50,000 for a new delivery van, kitchen renos in your triplex, or because your line of credit walked off a cliff. Over 5 years at 7%, what does it actually cost?
The monthly is roughly $990 over 60 months. Cool. Over the life of the loan, you will pay back around $59,400, meaning the interest, or financial backing, cost you $9,400; just under $2,000 per year. That represents 19% of the principal going towards the interest payments. So you decide to stretch out the loan to 7 years to reduce your monthly payments. At the same 7% interest, your monthly payments lower to $755, which feels easier to cover, but your interest paid over the life of the loan goes from that original $9,400 to $13,400. You are 40% more out of pocket when all is said and done to buy a couple more years to repay. Time is money, as they say. A good broker will run these scenarios and, as a client, you should not hesitate to ask for alternative options for loan terms. Sign only when all the information is at hand.
A final note for our brokers out there, the $50,000 example is perfect for showing clients the power of amortization, and the difference between that and a “term.” Comparing 5 and 7 years and the cost of those will be the difference between short term gain and long term referrals. Ask your client, “Do you want an extra $235 in your pocket every month, or do you want to save $4,000 in total interest?” Their answers may surprise you and will give you valuable insight into their financial personality.
TL;DR: Emily’s One-Minute Version
- Time and payment amounts are different. The amortization period is how long you have to pay the loan back fully. The term is how long your interest rate is locked in. Mixing them up is how borrowers get surprised when it’s time to renew.
- Five year terms are the vanilla ice cream of Canadian lending. They are common because they balance stability and flexibility. Three year terms are for people who think rates will drop. Two year terms are for gamblers or sellers. Variable terms are for specific, custom situations.
- The 5 loan types are Mortgages (secured by real estate), Working capital (fund your small business), Auto (your car is the collateral), School (usually government backed and gentler), Personal (unsecured and expensive).
- A $50,000 loan at 7% over five years costs roughly $990 per month and $59,400 total, meaning $9,400 vanishes into interest. Stretch it to seven years and your payment drops to $755, but your total interest jumps to $13,400.
- Brokers need to explain “amortization” vs “term “in the first conversation. Match the loan type to the actual need.
- Borrowers need to read the fine print on prepayment penalties. Breaking a term early in Canada can cost you thousands. Ask your broker to run multiple scenarios.
With all our content, we aim to provide information to better understand the mortgage landscape for both brokers and borrowers. But every situation is unique, so feel free to reach out to us, and we can walk through your specific circumstances to see if there’s a fit for working together. Let’s make a deal.
Contact sales@glasslake.ca to learn more.
