The mortgage term is the length of time you have agreed to a certain interest rate and a specified payment schedule. Most common terms range from as short as 6 months to as long as 10 years.
Rate and term go together like home size and location; you have to take both into consideration when making a decision. As we have heard before, “The lowest rate will save you hundreds, but the wrong term can cost you thousands.” Your mortgage term can have a greater impact on interest costs than the interest rate can. Since your term affects how long you are locked into a certain rate, if you were to make any unexpected changes, like breaking your term early, that will cost you. Or if interest rates don’t move as you planned, your term affects how long you are overpaying or underpaying on interest.
It is important to research your term options and ensure you are thinking of your future when making a decision. It is easy to find the best rate on the internet; it is harder to ensure you are taking a term that is right for you. See below for a brief review of the terms available to you today.
Most Popular Fixed Terms
1-year fixed: A short fixed term provides a comparable alternative to a variable rate as long as rates rise as economists expect. Because it is only a 12 month term, at the end of the year, you can move into another 1 year term or consider a variable rate- keep in mind, variable rates may have deeper discounts available a year from now.
2-year fixed: Assuming prime rate increases by 1.75% in the next 2 years, two-year terms are mathematically a little more attractive than a variable or 1-year fixed term. If you think prime is going to stay low, then go with a 1-yr fixed term.
3-year fixed: Second most popular term to a 5-year fixed. Reason being, 3-year rates are lower than 5 year rates today and when compared with other terms in an internal rate simulation, the 3-year term wins! If I had to pick a 5-year strategy for myself, I would choose a 3-year fixed term followed by two one-year terms. Be aware, with a 3-year term, the majority of the risk is in years 4 & 5.
4-year fixed: We affectionately call this the presidential term, because historically, Canadian & American interest rates tend to take a bit of a dip before a US Presidential election. If the 4-year term end doesn’t line up with an election, then 4-year rates don’t make sense unless you’re planning to break your mortgage in 4 years.
5-year fixed: This is the most popular term in Canada, and the term we get asked about the most. Great thing is, rates are still at an all-time low, making 5-year terms very appealing to anyone wanting security against rising rates.
Longer Fixed Terms
7-year fixed: Not sure why we have these as I have never had a customer take a 7-year term. If you are worried about interest rates, take a 10 year term and get 3 more years of payment security.
10-year fixed: This is the term for you if you’re not overly concerned about interest rate savings and you want to know what your mortgage payment will be for the next 10 years. That being said, statistics show that 90% of the time, 10-year fixed terms cost more than 2 consecutive 5-year terms.
Variable Terms
5-year Closed Variable: Historically, variable rates have prevailed over 5-year fixed rates. 77% of the time you will see savings with a 5-year variable rate versus a 5-year fixed rate term. If you believe that history will repeat itself, than a variable rate may be the way to go.
That being said, every major economist expects prime rate to continue climbing over the next year. If Prime rate goes up by 1.5% over the next 2 years, 5-year fixed rate terms will have an edge over the usual interest saving variable rate terms.
3-year Closed Variable: The average homeowner changes the terms of their mortgage on average every 3.5 years. The advantage of a 3-year term is you can renegotiate your mortgage terms earlier, than say the popular 5-year term. It is also attractive If you think variable rate discounts will get deeper in the next 3-years. Keep your eyes out for no-frills discounted rates, some restrictive conditions may garner you better variable discount.
1-year Closed Variable: 1 year fixed rates are lower than the 1-year variable rate. Take a fixed rate so you don’t have to worry about prime rate rising.
5-year Capped Variable: I am not sure what the appeal of this term is and I have yet to find out.
5-year Open Variable: An open mortgage is just a temporary band-aid, its main purpose is for short term funds. You are paying higher interest rates for the flexibility an open term offers. So keep in mind, when comparing an open to a closed term, closed variable terms are portable and they only have a 3-month simple interest payout penalty. So, if cash-flow is king, the closed variables are offering better rates than the open terms.
Other Terms and Features
Open HELOC (Home Equity Line of Credit): HELOCS are fully open products right around the 4% interest mark today. A HELOC is like a credit card with a really big limit, so be aware you are using it responsibly. If you absolutely need interest only payments, or are planning to pay off the HELOC quickly, or want to use it for interest offsetting, than a HELOC may be an option in that case.
Hybrids: A hybrid mortgage is part fixed term and part variable term. It is ideal for the borrower who can’t decide, it’s like diversifying your mortgage term. These aren’t the most popular products out there, mostly because the projected benefits are very dependent on what interest rates do in the next 5-years. If you don’t want to commit to a 5-year hybrid mortgage, take a look at a 3-year fixed term, which is somewhere right in the middle.
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