The Unsung One-Year Mortgage

rates-mortgagesPeople haven’t been lining up for short-term mortgages, given the mesmerizingly low rates on 5- and 10-year terms.

But if you’re a financially secure borrower and you believe that rate direction is random (it is), then 1-year rates shouldn’t be written off. That was my topic in this week’s G&M column.

By way of example, suppose you need to borrow for at least five years. If you’re not risk averse, you might consider options like a:

  • 5-year fixed
  • 1-year fixed …which lets you renew into a 4-year fixed at maturity (or any term for that matter)
  • 5-year variable …at a rate that’s ~20 basis points higher than a 1-year fixed

The total borrowing timeframe is the same in each case, five years. But the 1-year mortgage gives you an option to:

(a)  capture the maximum upfront interest savings and then keep enjoying low rates if borrowing costs stay low, or

(b)  switch to a longer term after 12 months if rising rates start stressing you out.

When to lock in is always the hard part. Most folks who try to time the market find it to be a losing proposition.

But some people take the guesswork out of it by using pre-set rate levels to determine when to convert. For instance, they might ask their mortgage planner to lock them in if the lowest 4-year fixed rate has risen above 3.25% (an arbitrary example).

This approach is similar in principal to a stop-loss order in trading.

A “stop-loss” gets you out of a trade at a pre-set loss. That lets you determine your risk in advance and prevent emotional and costly market timing.Mortgage-Stop-Loss

The challenge with most 1-year terms, compared to variable rates, is that you usually have to wait until three to six months before maturity to secure (hold) your renewal rate. By contrast, most variable-rate mortgages let you lock in at any time. That makes them preferable to 1-years in certain situations.

Other variable and 1-year differences:

  • A variable rate drops when prime rate drops.
  • A 1-year mortgage fluctuates less, potentially letting you hold low rates for longer than a variable.
  • A 1-year is currently cheaper up front (because the rate is lower than a variable).
  • A 1-year lets you switch terms at maturity at the best available rates. (You’ll rarely get the best rates when converting a variable mortgage to a fixed rate during your term.)

One unique case is the 1-year “convertible” mortgage. It lets you lock into a longer fixed mortgage at any time. In other words, you don’t have to wait until six to nine months into your 1-year term. Convertibles are harder to find but quite flexible if you can locate one that’s cheaper than a variable rate.

All-in-all, are 1-year terms right for most people? The answer is no. But they’re definitely right for more people than the 6% of borrowers who actually choose them.

More: Globe Story

The usual disclaimer: Exceptions apply when it comes to term selection. Please seek personalized advice.

Rob McLister, CMT

  1. Excellent piece in the Globe, Rob. I agree wholeheartedly, definitely more than 6% of Canadians can afford to take the risks of 1-year fixed mortgages.
    In my case, I enjoyed a 1.7% rate on a one-year mortgage for 2011. That resulted on bi-weekly payments of only $370, on a quarter-mil’ mortgage! And paid more towards principal than towards interest, even though it was year one of my amortization. Unfortunately that rate is no longer out there but rates are still low enough at the one-year node to make it a serious consideration.
    Also liked how you pointed out how wrong economists have been over the past three years in predicting rising rates, and how they have such a herd mentality.

  2. Hi, Does anyone know which lenders have free switch programs on their one year mortgages? I find that not many do.

  3. Rob makes some great points in his Globe article. Why would anyone take Variable at these one year rates? Linda, you are right, not too many lenders are lined up to do a free switch to a one year.
    This very rational 1 -year rate concept really underlines the problems associated with collateral charges and sky high discharge fees which are two points Rob has also written on extensively.
    Those with low mortgage balances find $350.00 plus discharge fees and evil “re-investment” fees simply destroy the advantage of shopping for low rates. Why would someone with a $100K balance change banks on renewal for a move to shorter term rates if their existing FI is hammering them with $500.00 plus fees. The math just falls apart. I applaud the government’s moves to make mortgage penalties very easy for the consumer to understand but I hope that full disclosure of discharge fees will soon be mandated and I don’t mean the fine print in the disclosure statement signed in the lawyer’s office the day before closing. How about a big print statement that needs to be attached to every mortgage commitment.

  4. Excellent point Rob Butler…discharge fees and penalties should also be disclosed up front. Not to mention any ‘freebies’ given by the FI are also recollected. Without this, it definitely has created unfriendly waters for the broker community.

  5. Great article – many clients do not use this term to their advantage!
    Ron – I agree with you that the “evil” re-investment fees+discharge fees ruin many a deal. This makes many clients not want to move unless the broker can cover these costs for the client. Question – what lenders do not charge the re-investment fee???

  6. Funny to read this, as we used option 2 last year.
    We went from (initial) 1 year fixed (Mar 2012) at 2.6% renewed to 4 year fixed (Mar 2013) at 2.85%. It was just that now our bank (National, QC), no longer offered 2.6% on one year fixed, and for the 2.74% they now offered (1 & 2 year fixed) the difference with 4 year fixed was so low that we just went for the more safe option.

  7. Good point, when I called our mortgage company last week to ask how much it would cost to break our mortgage as we want to pay it in full 4 years in to a 5 year term. The first thing she says, all the information you need should be in the documents you signed in your lawyers office.She then proceeds to give me the run down of all the charges. It was fine print alright.

  8. What about 2.49% 2 year fixed!!! BMO has it. Let’s us enjoy low interest rates now, and still only leaves us susceptible to a massive rate increase for 1 year and 9 months. Hard to lose I think…however it’s only a 115k mortgage and we have good incomes/cashflow to tolerate the risk. We’ll spend the next 2 years knocking the bejeesis out of this 116k at this low rate, and then even if rates have doubled in two years when we have to renew, no big deal, we will have already saved a tonne.

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