10-Year Terms: More Taste, Less Filling

10-year-fixed-mortgageWith the recent dip in long-term funding costs, lenders are finally sharpening their pencils on 10-year mortgage pricing.

Decade-long rates haven’t been this cheap in virtually forever.

Some brokers are quoting as low as 4.34% today, whereas most lenders were over 5% last quarter. (Not that long ago, 4.34% was considered good for even a 5-year rate, let alone a 10-year.)

With 10-year mortgages going “on sale”, we did some calculations to see how they stack up against the most popular term, the 5-year fixed.

Looking back through history, 10-year terms have rarely come out on top. If you opted instead for two consecutive five-year fixed mortgages, you would have saved money roughly 9 out of 10 times. (See: Fixed Mortgages: 10 Year vs. 5 Year)

Today, however, 10-year rates have nosedived and lenders are stubbornly refusing to pass along lower costs on 5-year terms. So it’s worth a look to see if the tables have turned.

To do this, we ran a little simulation with these parameters:

  • A starting 5-year fixed rate of 3.19%
  • A 4.39% 10-year fixed rate
  • Equal payments in the first five years (i.e.  the monthly payment is topped up on the 5-year fixed to match the 10-year fixed payments)
  • A 25-year amortization

The result is that 5-year rates would have to jump roughly 3% in 56 months for a 10-year fixed to cost less. (We say “56” months instead of five years because borrowers can hold renewal rates at least four months prior to maturity.)

To put a 3% rate increase in perspective:

  • The last time rates leaped that high was 17 years ago in 1994
  • It would imply 5-year bond yield of roughly 4.25%, assuming mortgage spreads stay the same (which they won’t, but it’s a fair guess anyway). A 4.25% 5-year yield is well above the long-term (2001-2011) average of 3.43%.
  • With the BoC’s modest 2% inflation target and lackluster economic growth forecasts, many would argue that an up-move over 3% is fairly unlikely in 56 months (but not certainly not impossible).

Now, this is not to say 10-year terms are pointless. They have their applications. Two examples might be the homeowner with extreme risk aversion or the landlord who wants to lock in a cash flow spread for the long-term.

Either way, you’ll pay a hefty cost up front to know your rate for years 6-10 in advance. Other things being equal, taking a 10-year term will guarantee that you pay roughly $6,000 more interest than the 5-year fixed. That’s in the first five years alone, and it’s $6,000 more for every $100,000 you borrow.

Of course, if rates stay low for the next five years, you can always break your 10-year term after 60 months. In that case, you’d generally pay a 3-month interest penalty, assuming there were a cheaper mortgage to switch into. When feasible, doing this does reduce the downside of a 10-year term, but you’ll still be out $6,000/$100k of mortgage, plus the penalty.

All told, recent rate cuts have made 10-year terms less bad, but they’re not tantalizing yet. They’d probably have to crack the psychologically important 4.00% barrier before homeowners start biting in significant numbers.

Rob McLister, CMT

  1. exactly L.S…..why not here….gee that would mean the greedy ol canuck banks would only make profits in the millions and not the billions….

  2. Greed is everywhere. Cure doesn’t exist.
    Once in a while the greed is slapped in the face, but recovers pretty quick and outgrows all obstacles.

  3. banks better ease up on the greed or pretty soon they’ll have zip customers…u see that ING just dropped their 10 yr rate to 4.49…rbc is over a point higher ditto cibc…hey boys wipe some of that greed off your lips and get in the game

  4. I think at 4.00% 10 year terms would be very appealing for a lot of families with high child-related costs where cost-certainty is an issue, particularly daycare or university.

  5. You get 30 year mortgages in the US because the US government socializes the interest rate risk through Fannie and Freddy. Nothing to do with the banks.

  6. 10 yr fixed rarely, if ever, works to benefit the client… but it’s been good for some brokers…
    there is a well known broker in Oakville that was selling 10 yr fixed, like no other broker before him… yes, he was great at selling 10 yr fixed..
    but then in the early to mid 2000’s, he realized that 5 yr fixed was consistently lower.. he called his clients, advised them to refinance, pay penalty to ‘SAVE MONEY’ and take the 5 yr fixed…
    soon after, he again realized that 5 yr fixed was not the right product… Variable rates could be had at prime less 0.75%… so what did he do? yup… you guess it.. called clients, advised them to pay penalty and refinance to ‘SAVE MONEY’..
    gotta hand it to the broker… 3 mortgages out of one… glad to say, not all brokers act or think like this… can you guess who that broker is?

  7. This is unbelievable that someone would consider a 10yr rate. Isn’t it clear by now that long rates cost a lot more for a marginal increase in “peace of mind”? I took a 2.45% 2yr rate recently renewable in 18 months with no penalty. Free money practically. Been almost like this forever as I remeber during my homeowner career. And it’ll be like this for a long time to come. Why even talk about 5yr or longer rates? And all those calculations presented are a waste of time since they all conclude one thing only – go long and you’ll pay dearly.

  8. I happen to agree that 10 year mortgages are a poor choice for most. Then again I would never be so ignorant to suggest that my choice is right for everyone.
    Expecting past rates to continue indefinitely into the future is just naive. Drazen there will come a time when rates rocket higher and your cockiness bites you in the a$$.
    The difference between your 2 year mortgage and a 5 year mortgage is .75%. That is nothing in the big scheme of things. Rates can move double that in a year or less.

  9. Why we can’t take mortgage from the BoC directly ? For primary residence only. No tellers, no negotiations, BoC variable rate.
    That will be so nice.

  10. who wouldnt take a 10 year at 4 per cent…dont think the rate will ever go that low but hey this is christmas and one can always dream

  11. You are misinformed. Canada has CMHC and others for the same purpose.
    Long-term rates are so low because the Federal Reserve has been buying them down like crazy to encourage people to buy homes.
    Moreover, like every other market in the U.S. compared to Canada, there is more competition, resulting in greater benefit to the consumer.

  12. I totally agree with you. I find it interesting that people don’t mind paying a premium for perceived security, when most households are really only 1 or 2 job losses away from not paying the mortgage at all. Regardless of whether its 2.25% or 4%, it would be difficult to pay a mortgage while unemployed. Maybe it’s the 23% in the public service who don’t worry about job loss that think this way? Ironically, they should be the ones going variable.
    In reality, a 5 year fixed is hardly risk-free, as one faces 4-6 renewals during the liftime of the mtg and larger penalties if they have to (and likely will at some point) break it. A competitive 15- or 30- year fixed would be nice to have in Canada, but why would Cdn banks take the risk of paying on long-term deposits, when Cdn consumers are willing to hold that risk for them?

  13. If you’re talking about the risk of paying more interest, a five year fixed is much lower “risk” than a ten year fixed. That should be obvious if a five year costs less than a ten year 90% of the time.

  14. CMHC socializes risk for long ams as does Fannie and Freddie. This doesn’t adequately explain why a 30 year term can be obtained in USA though. I think it may have more to do with the 30 year Tresury.

  15. I’m not sure I understand or agree with what you’re saying. I thought the “risk” was in renewing at a higer rate (or risk of the unknown, scary future). Therefore, the longer the term, the less the number of renewals at potentially higher interest rates, and the lower the risk.
    If you choose to take that risk from the banks by choosing a shorter term they don’t have to hedge and you save money usually.
    I was trying to make the point that risk is a relative concept and nothing is truely risk-free. That even though a 5 year term (or less risky 10 yr for that matter) offers payment certainty for a longer period of time, in this current world of shrinking wages and increased joblessness, it doesn’t matter what your rate is if you don’t have a job at the end of the day. Not even a fixed 30 year term would remove that risk.

  16. LOL and how would the banks maintain their earnings?
    Their simply are not enough teachers, police, firefighters and other civil servants to buy rental properties to make up that shortfall.

  17. Considering today’s unique spreads and economy, history is a weak guide when choosing a mortgage. Taking a 2 year mortgage to save 1/2% for 18 months is just gambling IMO.

  18. Interesting article. I have to say though, the numbers used are very recent (ie. last 10 years), and the last 3-5 years aren’t exactly fair comparisons when trying to predict the next 5-10 years. Reason being ‘the great recession’, the reason for all this incredibly cheap money, to keep our economy afloat. For example, let’s look at the likelihood of a 3% jump in fixed rates another way. A 4-4.35% bond yield, while lower then the current 10 year average (due to ‘the great recession’ of the last 3-5 years), was normal any year before 2007. Factor in the fact that bond spreads will likely return to 2-2.5% (as the spread tends to normalize after recessions), and we’re looking at fixed interest rates of 6 – 6.85% in 5 years.
    The question is, in 5 years time, what do we think the mortgage rates will be? Prime will probably be around 5 – 6%, and a 5 yr fixed will be at least 6%. I think that’s pretty standard prediction standing where we are today, isn’t it?
    So using the example in the article, 3.19% for the next 5 years, then 6% in the following 5, makes for an average rate of 4.60 over 10 years. So locking in a 10 yr rate at 4.34% today is sounding a lot better isn’t it? Save money, avoid risk, and don’t think about rates for 10 years. Sounds good to me.
    Wild card: How will prime behave from 2016 – 2021? Assuming we see a return to prime – 1% mortgages in 5 years, best course may be to go 3.19% 5 yr fixed now, then 5 yr variable in 2016 and hope the economy stays the course and prime remains low…

  19. 10 yr or 5 yr,
    I would disagree with your numbers. Yields have been low for a while. The 5 year yield was less than 4% in 2005, 2004 and much of 2003. Canada will not see inflation like the 80s and 90s again so rates could stay below longstanding averages for many years.
    Regarding “an average rate of 4.60%,” the average rate is inconsequential because principal is paid down more quickly in the first five year term, especially if you make 10 year fixed payments.
    P.S. I’m confused by what “spread” and “fixed interest rates” you are talking about in the first paragraph?

  20. The best bet is to have your mortgage broker show you the breakdown of 5year versus 10 year mortgages. Although the 5 year may save you more in the longrun with the ability to get the best rates every 5 years- the 10 year does have its advantage of long term stability of knowing what your payments will be, thus allowing you to plan your finances further out. For some, the stability is worth it.

  21. I’m talking about the (5 yr) bond yield-mortgage rate spread, and meant a 5 yr interest rate.
    Okay, maybe you’re right and yields do stay low. Even at a 3.5% yield and 2.5% spread, you’re looking at a 5yr fixed rate of 6% in 2016.
    My point was that if you go for a 5 yr fixed today, the attractive interest rate you’ll get will be offset by the higher 5 yr fixed rate you’ll get in 2016.
    Why are you saying the principal gets paid more quickly in the early part of a mortgage? As far as I know, the lower your principal gets (ie. the later into your amortization you get) the more principal you’re paying.
    I just ran the numbers on a mortgage amortization spreadsheet. Comparing 10 years at 4.34 VS 5 years at 3.19 followed by 5 years at 6%, the 10 year comes out ahead. Your total payments over 10 years will be $637 less and you’ll pay down about $2,300 more in principal.

  22. There is something wrong with your spreadsheet.
    Do the calculations again with a $100k mortgage amortized at 25 years with equal payments in the first five years.
    On a 10 year fixed at 4.34% you will pay $544.61 a month x 120 = $65353.20. Your balance will be $72,146.54 after 10 years.
    On a 5 year fixed at 3.19% you will pay $544.61 a month x 60 = $32676.60 in the first five years and be left with an $81,787.62 balance.
    In the second five year term the rate will be 6% and amortization drops to 20 years. For those five years you will pay $582.48 a month x 60 = $34,948.80 and have a $69,353.92 balance at the end.
    In total you make $2,272.20 less payments with the 10 year but your balance is $2,792.62 more. Net net, the five year terms cost $520.42 less than the 10 year.
    Lastly, your spread assumption is way off. 2.50% is not a normal spread and you shouldn’t use today’s abnormal rates as a guide. Somewhere around 1.40% is normal. That gives you a 5 year rate of about 4.90% assuming your 3.50% bond yield.

  23. Firstly, my spread assumption isn’t way off, it’s about right. Here’s what I’m basing it on:
    What are you basing 1.4% as a normal spread on?
    As for my bond yield, 3.5% is a conservative estimate, it’ll likely be higher. Here’s what I’m basing that on:
    As you said, don’t let today’s abnormal yields as a guide.
    Back to the numbers. Even using your own numbers, the two five year terms will cost $520.42 less then the 10 year. Over 10 years! That’s $52.04/year! $4.34/month!
    So, thank you for making my point: Taking a 10 year today and forgetting about the world of interest rates (for 10 years!!), being ASSURED that you’re getting a great rate over TEN years is a very viable option.
    $500 more for a great 10 year rate? Who in their right mind thinks only a risk averse person would be enticed by that? Let’s get it right folks, EVERYONE should be enticed by that.
    As I said at the beginning, the only thing going against the 10 yr rate at this point, is the unknown performance of the variable rate mortgage from 2016-2021. If that performs average or better, the 10 year losses out (in earnest).

  24. You’re using the wrong spread. The 2.50% spread you’re quoting is posted rate minus the bond yield. That has nothing to do with what discount fixed rates will be in five years.
    If bond yields jump to 3.50% like you assume, discount fixed rates will be an additional 1.40% above that if history is a guide. That equals 4.90%, not 6.00% as you wrote.
    Remember that the difference between a 5 year and 10 year is $500 ONLY IF rates increase 3%. What I’m trying to explain is that a 3% bond yield increase is extreme and unlikely. Therefore a 10 year fixed will probably still be a waste of money.

  25. Late response –
    (some of us actually go on holidays)
    , but Firstline in the”old” days did offer the 15, 18, 22 and 25 yr ams ( no 30 yr ams at that time !)and eventually reduced the offers to 15 yr and 18 year and finally discontinuing the long terms.
    Apparently, the public felt that FIRSTLINE was the somehow the BAD Guy, ( no one else was offering over 10 yrs) because Firstline must have inside knowledge that rates were going to stay low and were prepared to offer these long terms. Despite trying to indicate that Firstline had simply gone out and packaged some monies to allow this to happen was lost on the “feelings” of many consumers; they were going to get done in somehow by the bad bank. With 3 month’s penalty being the maximum by “law” on all mortgage terms over 5 years, it was a useful product for some

  26. I am being charged more than three months to break mine with Royal. I’m 3 Yrs into a 10 yr. Tercast 5.2 with about $170k left on mortgage and the want 3800 in penalty. What am I missing?

  27. Hi Jen,
    The law permits federally regulated lenders to charge more than 3-month’s interest on a 10-year mortgage, up until five years have elapsed. At that point the penalty is capped at 3-month’s interest.

  28. But that is why the ‘greedy’ Canadian Banks actually make money and are solvent as compared to the ‘dumb’ US banks. You cannot have it both ways!

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