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.
Picking the right term is often far more important than saving a few basis points on the interest rate. That’s because the wrong term can be costly when rates change, your finances change, or your living plans change.
Take some time and ensure you’re getting the optimal term for your time horizon and risk appetite. Below you’ll find bite-sized reviews of several different terms to give you a running start.
Popular Fixed Terms…
Here’s a breakdown of all the primary terms, as of this moment:
1-year fixed: One-year rates are still near prime for a quick close. That’s about the same price as a variable. The benefit is that you’re not locked into a variable for 4-5 years without a discount. With analysts expecting the widespread return of variable-rate discounts, why get a variable 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 3-4 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 could be cheaper than a 2-year. If, however, you’re worried that rates will jump before next June, choose a 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 5-year term.
4-year fixed: Four-year terms no longer have enough of a discount to justify the risk of forgoing a 5-year term. That said, 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 lessen or eliminate your mortgage penalty.
5-year fixed: “Old faithful” is still the most popular term, and she’s looking better. Full-featured 5-years are still just ~0.4% 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 may cost you the least of any 1- to 5-year (fixed or variable) term.
Longer Fixed Terms…
7-year fixed: 7-year mortgages cost over 1% 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 5.25%, 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.
5-year closed variable: Discounts to prime are back! Prime – 0.10% can now be found in a half dozen places. Compared to a 1-year at prime, however, that 0.10% savings won’t do much for you.
Barring any shocking economic developments, prime rate will not go lower. Therefore, most people are looking at variable rates with one of two things in mind:
They want to time the market (enjoy low rates in the short term and lock in before fixed rates go up)
They think rates are going up ~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- to 5-year term 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 bigger discounts to return?
5-year capped variable: You’ll get 2.90% today and never pay over 5.84%. That’s swell, but (based on our calculations) the numbers don’t make sense. Moreover, 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 Cash Back Downpayment: There’s at least one lender who’s getting aggressive on these. That’s made them more comparable, in terms of total cost, to the insured 100% financing mortgages of yesteryear. Now we hate cash backs a lot less. That said, if you can’t put down 5%, shouldn’t you 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 (0.15% 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: RBC has shaken things up by leading the industry and cutting its secured LOC rate to prime + 0.50%. Hopefully the other lenders follow. That said, unless you need an open mortgage, go with a discounted variable readvanceable instead.
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, a straight five-year fixed term is the better option.
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!
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