The most common term length for a mortgage is five years, and this is typically the first option quoted by banks and brokers alike. 

But is the five-year term really what is best for you?

A few years ago, shorter-term mortgages carried lower rates than longer terms. When mortgage regulations changed in late 2016, the cost of funds for shorter terms increased for mortgage lenders, which resulted in them needing to price them higher. Ever since, five-year fixed terms represent the lowest cost of funds to mortgage lenders, which means they will often carry the lowest mortgage rates.

For example, today’s lowest 5 year fixed rate is 2.39%*, however, the lowest 3 year fixed rate in the same pricing category is 2.69%.* Pretty big difference! For this reason alone, it’s almost always 5 year fixed rates that are being quoted these days.

 

Should Variable Rate Mortgages Be Considered?

Variable rate mortgages are also priced higher than fixed, making them less attractive options for the vast majority of borrowers. The lowest 5 year variable rate is prime -1.25% (2.70%). While the discount off prime is one of the largest in history, prime rate still remains high, and the Bank of Canada has been committed to maintaining their overnight right (which is what determines prime rate). For the time being at least. It’s quite possible that prime rate will drop following the next BOC rate announcement on October 30th. We’ve been waiting for a drop since the spring of 2019 and they have disappointed us ever since. I’m sure it will come… but then the question is ‘when’. If they had their way, they’d be increasing rates… but that would result in economic disaster, so that won’t be happening anytime soon. 

 

Should Shorter Term Mortgages Be Avoided?

There are two reasons where one might be more interested in a shorter-term mortgage:

 

  • You will only need the mortgage for a couple of years.

If you have plans to sell your home in a couple of years, then you may want to choose a shorter-term mortgage. In order for this to make sense, the shorter-term rate would have to be fairly close to the 5 year alternative. In the example above, the 5 year fixed rate is 0.30% lower than the 3 year term. In that case, it will still likely make more sense to choose the longer term, even if it means paying a penalty down the road. The penalty would need to be compared with the savings you would see from the lower rate in order to estimate the lower-cost option. This is a case by case basis which would need to be discussed in detail with your broker.

There are almost always options to port your mortgage over to the new property, which would save you from having to pay a penalty, however. There are many variables involved in making this decision, so make sure let your mortgage advisor know your plans, so they can do the math and present you with your options.

 

  • You think rates are going to drop

If you believe that rates are falling and will be lower in a couple of years, then you may want to consider a shorter-term mortgage. There are many out there with this mentality, but this is nothing more than a guessing game. It’s impossible to know for sure and you may as well just flip a coin.

Last fall, economists were predicting that 5 year fixed rates would reach 5-6% in 2021, which led many to seek terms greater than five years. Anyone who closed their mortgage in 2018 or early 2019 would have been given 5 year fixed rates in around the mid-3% range.

In February of 2019, everything shifted and fixed rates started plummeting down to the mid-2% range. A full one percent drop in just six months. It’s amazing how quickly predictions can change, so it’s important to realize that all anyone can do is speculate.

If you think rates are going to drop in a couple of years, you may as well just roll the dice and make a decision based on that. Anything can happen.

 

Fixed Mortgage Rates Rising

There is currently upward pressure on fixed mortgage rates, as I’ve been saying for the past couple of weeks now. At least four mortgage lenders have increased rates so far, with two increasing as recently as today. There are many however who are still holding off with increasing their rates, but if bond yields continue to rise any further, then they will have no choice.

If you have a mortgage that is coming up for renewal within the next 90 days, or if you have a purchase closing within 120 days, it’s best to get an application in ASAP in order to get your rate locked in ahead of any further increases.

 

 

Paul Meredith is the author of the Amazon #1 best selling book, Beat the Bank – How to Win The Mortgage Game in Canada, and has ranked as one of the top 75 mortgage brokers in Canada since 2016. He was a finalist for Mortgage Broker of the Year in 2018, and can be seen as the exclusive mortgage broker on season two of TV’s Top Million Dollar Agent.