Mortgage Term Review

Updated: September 14, 2009

Picking a mortgage is like buying a diamond. It’s an expensive purchase; you don’t want to screw it up; and good advice is key.

The first decision that most mortgage shoppers make is with their term. Below you'll find bite-sized reviews of several different terms to give you a running start.

There's been a few developments since our last update in July:

The economy has strengthened slightly

Fixed rates have improved (thanks to horizontal bond yields and shrinking spreads)

Variable rates have flat-lined, as expected.

Here's a rundown of all the different terms as of this moment in time:

Popular Fixed Terms…

1-year fixed: 2.25% to 2.45% variable rates are like a siren's song. Don't listen. A 1-year fixed may be slightly more expensive but it keeps you from being trapped 4-5 years in a variable rate above prime. With analysts expecting the return of "prime-minus" variables, why pay prime+ now? Just be sure to pick a 1-year that's convertible to either a fixed or variable-rate at any time.
2-year fixed: There is not as much relative value in 2-year terms as there was 2-3 months ago. One-year rates are now ~0.40% lower. Therefore, if rates stay flat (as the BoC expects), and you lock-in your renewal rate 120 days in advance, back-to-back 1-year terms should be cheaper than a 2-year. If, however, you think rates are going up before next June, choose a 3- to 5-year term instead.
3-year fixed: You’ll save big interest over the first three years compared to a 5-year fixed. The trade-off is more risk in years 4 and 5. If fixed rates rise over 2% in the next few years, you’ll likely do better with a 4- or 5-year term.
4-year fixed: Four-year terms are about 0.40% cheaper than 5-year mortgages. If fixed rates go up less than 2.25% in the next 48 months, a 4-year should be more economical. If there's a chance you'll break your mortgage in four years (people refinance every 3.5 years on average), a 4-year fixed will also lessen or eliminate your mortgage penalty.
5-year fixed: It's still the most popular term. Full-featured 5-years are now only ~0.35% above their all-time lows. With most “experts” calling for rate hikes in the 2nd half of 2010, you’ll be sleeping easiest in a 5-year. If rates jump 2.50% or more, a 5-year fixed will cost you the least of any 1- to 5-year (fixed or variable) term.

Longer Fixed Terms…

7-year fixed: 7-year mortgages cost 1.20% more than 5-year terms, for just two more years of rate assurance. As a result, they don’t sell very well. If you’re that concerned about risk, take a 10-year for the same price.
10-year fixed: The decade mortgage is available for just 5.19%, or thereabouts. That’s not far from its record low. What’s more, you can get out after five years with a reasonable penalty (i.e. there's no dreaded IRD). On the other hand, for a 10-year to beat a 5-year, rates would have to go up--and stay up--for a while. That possibility exists, but the "insurance" will cost you.

Variable Terms…

5-year closed variable: Prime rate is at or near the bottom, so most people are looking at variable rates with one of two things in mind:
1. They want to time the market (enjoy low rates in the short term and lock in before fixed rates go up)
2. They think rates are going up about 2% or less in the next five years
If your plan is the former, be warned. It's way too easy to be wrong or late when locking in. Take a 3- or 5-year now. You can't rely on your lender or broker to warn you before rates go up, and rate charts are prone to headfakes.

If your plan is the latter, why trap yourself in a variable rate now when you can choose a convertible 1-year fixed and wait for “prime-minus” to return?
5-year capped variable: You’ll get 3.25% today and never pay over 5.49%. That's swell, but if you’re that worried, why not pay a bit more for a fixed rate now?
5-year open variable: Opens are a temporary solution and you'll pay a premium for their flexibility. Unless you’re going to terminate early, save the 0.60% and choose a closed variable or 1-year convertible instead. Remember, closed variables and 1-year convertibles are portable and have only 3-month interest penalties.

Other Terms and Features…

5-year $0 Down: Nothing's changed here. Still hate’em. Lenders pillage borrowers with no-money-down products. If you can’t put down 5%, rent and save for a down payment.
5-year no-frills: If there’s any chance you’ll need over 5% pre-payment privileges, you’ll be sorry for choosing one. If not, you’ll save a smidgen (0.10% or so). As recently as May, no-frills discounts made them worth considering. At the moment, don’t bother.
Readvanceables: Still love’em. They’re the “must have” mortgage if you’ve got 20%+ equity. Readvanceables make you liquid, and you can’t put a price on liquidity. More…
Open HELOC: At prime + 0.85%, the All-in-One is our favourite. It has interest offsetting and automatic everything. We just wish the LOC was at prime again, like last December.
Hybrids: A hybrid mortgage is part fixed-rate and part variable-rate (and/or part long term and part short term). Hybrids offer a nice amount of rate diversification. If you can’t decide between a fixed or a variable, check them out. That said, if you think rates will rise a fair amount, four- or five-year fixed terms are lower-risk.

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The Disclaimer: There are a million and one exceptions to everything above and market conditions change almost daily. Therefore, do yourself a favour and consult a mortgage planner for a current comparison of the options. Remember, these opinions are just that. They are not recommendations or advice. Qualifying is always contingent upon approved credit. All information is based on present market conditions, rates and expectations--each of which may change without notice!