Mortgage Terms: Stars & Dogs

champion dogAfter “What is your best rate?” the next most popular mortgage question is probably “Which term do you recommend?” — or a variation thereof.

But it’s tough to generalize about the best mortgage because borrowers have unique needs. To get around that, we have to use limiting assumptions and make a best guess at the risk/reward of each term. And that’s how we’ve picked the stars and dogs in this week’s Globe column.

After that Globe piece went to print, a few readers emailed asking, “What’s wrong with variable?” and “What’s wrong with a 4-year fixed?”

In the case of variables, it’s a question of how much reward you can expect for the risk of rates rising. (Economists claim we’re still two percentage points below “normal” rates, for what that’s worth.)

The reward part of the equation is seemingly more easy (that is, unless rates unexpectedly drop, which throws all of this math out the window). Assuming economists, the Bank of Canada, OSFI, the Department of Finance, politicians, commentators and your neighbour’s dog are all right, then rates will return to normal. So, if you take a variable, you’re banking on saving roughly 65 basis points up front versus a 5-year fixed.

But even if the prime rate rises only one percentage point in 2015, and nothing more, going variable today will cost you more than a flexible 5-year fixed mortgage with a fair penalty.

As for a 4-year term, if rates jump 100, or even 200, basis points over the next five years, both a 3-year and 5-year fixed beat the 4-year fixed based on projected interest cost alone. (The assumption is that you renew the 3-year into a 2-year and the 4-year into a 1-year.)

Keep in mind, the above is based on:

  • a strong applicant with provable income
  • financing for a marketable owner-occupied home
  • no need to break the mortgage for five years
  • equal payments in all cases (i.e., if you have a 3-year fixed you’d make the equivalent of the 5-year payment — to keep the cash flows apples to apples)

There are so many other considerations of course, so competent, personalized advice never hurts.

More at Mortgage shopping? Two stars and four dogs

Rob McLister, CMT (email)

  1. This is very insightful, I don’t think every broker gives enough thought to these rate premium concepts when they consult with clients. We often hear requests for terms longer than 5 years and at our office we always try to talk the clients out of it.
    One point to consider on Variable Rate. We have been hearing a constant refrain from economists that Prime will go up in the next 12 to 18 months. The problem is they have been saying the same thing for the last 3 years. They just keep backing it off.
    I have a concern that since I really just do not know when Prime is going up that I should not make suggestions as to when it will happen. For clients without a specific time horizon we offer 3 year fixed and 5 year fixed and variable with a big “darned if I know which is better” attached. I don’t think it is a job requirement of a mortgage broker to predict the future, ask questions to analyse the clients goals for a time horizon; present the rate possibilities and let the client decide.

  2. Why not take advantage of the variable rate, and then lock in a 5 year fixed when the prime rate shows signs of moving?

  3. Thank you for posting the article.
    What would be a good 2-year mortgage product(fixed or variable)?
    We have $100,000 remaining and we want to renew for a 2-year term and be done. Two strong income earners in mid 30s with no other debt and no children yet.
    A bit aggressive compared to our friends but owning a house outright will great.

  4. No one is smart enough to time when to lock. How do you know when rates are going for good or if it’s just a fakeout move?
    By the time the Bank of Canada raises rates, bond yields will have already taken 5 year fixed rates higher. Then you’ll be too late.

  5. Gambling your mortgage rate is not wise. And timing rates is not wise either. If a rate increase will unbalance your budget, then you should be more concerned with the size of mortgage you’re taking on rather than it’s rate. Whichever rate you chose, there will be a flip side to you’re reasoning. My advice for those who want savings: always choose the lowest rate available. This will most probably be a variable or a short term rate. Even if rates go up at renewal, you need to keep choosing the lowest one available. If your reasoning is to choose a longer term due to current ‘low rates’, then you’re timing the market. If rates do go up, you’ll end up paying the hike later on. The ultimate goal is to pay the lowest rate possible and pay off your mortgage as quickly as possible.
    Here’s something to ponder on….What are those who took a ten year rate at 3.89% saying today?????? Some lenders are back at 2.99% for 5 years!

  6. Personally I’d rather avoid any chance of hike for 5 years when the difference between fixed and variable is so small. I’d argue that it’s “gambling with your mortgage rate” to do otherwise.

  7. @ Underwriter, that tends to be my concept, since I have no way of knowing the exact future of rate timing I default to the lowest available rate.
    That being said; if I am offering 2.99% on a 5 – year fixed if my client’s personality is such that they are risk adverse it’s a darn good rate at 2.99%
    Your point on 10 – year terms is well taken.

  8. Hi IG,
    Just 2 years from mortgage freedom. If we could all be so lucky… :)
    Canada has no competitive 2yr variable rates so you’d be looking at a 2yr fixed. Rates for well-qualified borrowers are 2.59% or less. Check out Street Capital, First National, MCAP, London Life and CIBC. All have exceptional rates on 2yr terms. A broker is needed for the first three lenders.
    Good luck!

  9. Robert,
    Thank you for your comments. We are nearing the end of our 5-year variable term with Firstline and will be looking at a 2-year fixed mortgage, as per your suggestion.
    Hubby and I have been reading your blog since we purchased our first house in 2009.
    Thank you for all your hard work on

  10. Totally agree…it is tempting to choose a 2.99% if someone wants peace of mind. I just think that society is making their decision based on the numerous, speculative forecasts giving the impression they should ‘lock in now and avoid upcoming rate hikes’.
    All I’m saying is rates can jump just as they can slump. Why pay more for the unknown?

  11. Hi UW, Re: “Why pay more for the unknown?” The short answer is that adverse rate movements can really hurt some people. These folks need to lay off that risk to the lender. The long answer will be part of tomorrow’s story. Cheers

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