Updated: August 17, 2010
Key developments since the last update on May 25:
- The Bank of Canada initiated its first rate-hike cycle since 2004.
- Anxiety over Canada’s economic recovery drove down the benchmark 5-year bond yield to 15-month lows. Fixed mortgage rates have been slowly following lower.
- Discounts from prime rate improved slightly while variable rates have increased on an absolute basis.
Why Is Your “Term” Important?
There’s an old saying: “The lowest rate will save you hundreds, but the wrong term can cost you thousands.”
Put another way: your mortgage term can have a far greater impact on interest cost than the up-front interest rate. That’s because your term determines the length of time you’re locked into a rate. That, in turn, affects how long you’ll overpay or underpay, relative to the other available options.
The wrong term can get mighty expensive if interest rates deviate from your assumptions, or if you need to break your mortgage early. It therefore pays to make the right choice from the get-go.
Remember: Almost anyone can find a low rate by browsing the Internet. Picking the right term on the other hand isn’t so easy. Take some time, get good advice, and nail the right term the first time. Below you’ll find bite-sized term reviews to give you a running start.
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Popular Fixed Terms…Here’s a breakdown of the most common mortgage terms:
- 1-year Fixed: If rates rise as economists expect (see: mortgage rate forecast), then a deeply discounted 1-year term is mathematically a good alternative to a variable. At the end of the term, you can move into another 1-year, or you may want to consider a variable rate—possibly at a better discount than today.
- 2-year Fixed: Rates on two-year terms aren’t currently low enough to warrant much consideration, relative to a 1- or 3-year fixed.
- 3-year Fixed: This is unquestionably the sweet spot thanks to Merix Financial’s 2.90% three-year special. It literally blows away other terms in our internal rate simulations. If we could only pick one strategy for the next five years, a 2.90% three-year term followed by two one-year terms would be it. As always, the trade-off with a 3-year term is more risk in years 4 and 5.
- 4-year Fixed: At today’s rates, 4-year mortgages are a waste of time unless you plan to break your mortgage in four years. (Remember, however, that people do refinance every 3.5 years on average.)
- 5-year Fixed: Insurance rarely comes cheap, and five years of rate security will cost you a bundle up front. If rates rise more than expected, however, this conservative play could pay off.
Longer Fixed Terms…
- 7-year Fixed: The spread between 5- and 7-year terms is about one point, which makes seven year terms almost useless from a mathematical perspective. If you’re that concerned about risk, take a 10-year term for 40 basis points more, and get three more years of rate protection.
- 10-year Fixed: The decade mortgage is now available just above 5%. Some consider that a pittance for 10 years of knowing your payments. What’s more, 10-year terms let you out after 5 years without paying a dreaded IRD penalty. On the other hand, for a 10-year to prevail, 5-year fixed rates would have to soar over 3.64 percentage points by the time your 5-year term matured. We haven’t seen any reputable analysts calling on long-term rates to rise that much in 60 months. What’s more, history has shown that 9 out of 10 times, 10-year fixed terms cost more than consecutive 5-year fixed terms.
Variable Terms…
- 5-year Closed Variable: Don’t let “prime – 0.20%” advertised bank rates fool you. Prime – 0.65% (or better) is the new standard for 5-year variable rates.
Remember this though: Prime rate will continue to climb. Most people taking variables are betting that prime won’t exceed 5% in the next five years. (5% prime is the rough “breakeven” point between today’s variable and 5-year fixed terms).
If you plan to convert your variable to a fixed rate, taking a 3-year fixed term from the outset is the better plan. Then you don’t need to worry about market timing, and you won’t be stuck with your lender’s “conversion rate” when locking in.
- 3-year Variable: 3-year terms let you renegotiate sooner–which is good if you might need to break your mortgage in 3 years, or if you think variable discounts will improve in 36 months. In the 3-year market, you can find rates as low as prime – 0.75%.
- 1-year Variable: With 1-year fixed rates below 1-year variable rates, why bother with a 1-year variable?
- 5-year Capped Variable: Two words: stay away. More…
- 5-year Open Variable: Open mortgages are temporary solutions, and you’ll pay a premium for their flexibility. Remember, closed variables are portable, and they only have a 3-month interest penalty. Even if you break a closed variable in seven months and pay the penalty, it’s still cheaper than taking an open…at today’s rates anyhow.
Other Terms and Features…
- 5-year Cash Back Down Payment: Most people considering CBDP mortgages are pretty desperate to buy, so banks stick them with posted 5-year fixed rates. Here’s a novel thought: If you can’t put down 5%, rent and build up a down payment.
- 5-year No-Frills: No-frills mortgages are temporarily obsolete because you can find full-featured mortgages at a similar or better price.
- Readvanceables: They remain 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: Lenders are ever-so-slowly making HELOC rates more competitive. It may be a while before rates get to prime once again, but there are now at least six national lenders at prime + 1/2%. That said, if you’re planning to borrow a large amount and pay off less than 25% of your mortgage each year, save money and take a readvanceable closed variable instead.
- Hybrids: A hybrid mortgage is part fixed and part variable (and/or part long term and part short term). Hybrids give you rate diversification, which makes sense since no one knows how high or low rates will be in five years. Just remember, if you’re getting part short-term and part long-term, the lender may be less motivated to give you a great rate at renewal on the short-term portion. That’s because the lender knows you’re locked in with them on the longer-term portion.
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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 professional 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, current economist forecasts (we do not predict rates), and today’s rates and expectations–each of which may change drastically without notice!
