Interest rates have nowhere to go but up. No doubt you’ve heard this line if you’ve bought a home or had to renew your mortgage at some point in the past decade, followed by an eager banker or mortgage broker urging you to “lock-in” now.

Most homeowners in Canada prefer fixed rate terms for predictability and peace of mind, with five-year terms being the most popular. Yet despite its popularity, the five-year fixed rate is likely the least advantageous term for borrowers.

Long-Term vs. Short-Term Mortgages

Going Long: 10-Year Mortgage Term

For those looking for greater protection against (eventual) rising interest rates, a longer term is worth a look. A 10-year fixed rate mortgage today can be had for as low as 3.69 percent.

Another reason to consider a longer mortgage term: a safeguard against the possibility of a housing crash. What happens if prices fall 20 per cent or more in the next few years, wiping away your home equity before it’s time to renew? A 10-year term, while more expensive than a shorter term, does offer a double-dose of protection in case prices fall or interest rates rise substantially.

Certified Financial Planner Ed Rempel doesn’t buy the safety argument, saying that the risk of rising interest rates is ‘hugely exaggerated’ in the media and by the mortgage industry.

“Long mortgage terms are marketed as “insurance” to protect against a possible rise in interest rates. But most people are not good at math and don’t take into account the extremely low odds of a large rise, plus the huge cost of the insurance,” said Mr. Rempel.

A five-year fixed rate mortgage costs around 2.64 percent today while a two-year fixed comes in at 2.29 percent. Mr. Rempel says the difference doesn’t sound like much, but on a $300,000 mortgage this 0.35 percent premium costs $2,100 after tax for the first two years.

“This is expensive insurance to protect against a highly unlikely event,” said Mr. Rempel.

Stop Short with a 1-or-2-Year Fixed Rate Term:

If long-term mortgages offer peace of mind (for a premium), a short-term mortgage – such as a one-or-two-year term – gives homeowners the opportunity to save money in exchange for a bit of uncertainty when it comes to future interest rates.

With a one-year term, for example, homeowners get more flexibility because they can renew their mortgage in 12 months instead of in three-to-five years. At that time they can renew into another one-year term, lock-in to a longer-term fixed rate term, or take a variable rate at presumably a better discount than today.

Those who opt for a one-year fixed rate can also lock-in their renewal rate in just six to nine months – they don’t have to wait a full year.

So why don’t more homeowners choose a one-year term? According to data from Mortgage Professionals Canada, just one in 16 borrowers take a one-year fixed rate mortgage.

Mr. Rempel says that’s because people don’t want the headache of renegotiating every 12 months. But it’s a mistake to give up that negotiating power.

“From a financial planning perspective, I find that most people can benefit from some type of refinancing every two years,” he said.

The bottom line: Homeowners looking to save the most money year-over-year should consider a short fixed term of one-or-two years, while those looking for maximum peace of mind can find comfort in a 10-year mortgage term at rates under 4 percent.

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6 Comments

  1. Michael James on April 28, 2017 at 6:33 am

    Is this the Ed Rempel quoted as an expert for your article?

    http://mfda.ca/news-release/release-Sanctions201348/

  2. Chris on April 28, 2017 at 10:02 am

    I am finally mortgage-free, but for decades I almost always went with the lowest variable rate mortgage I could find. I saved thousands of dollars by not opting for the “safer” route. Intellimortgage was especially useful for our final deal.

    • Echo on April 28, 2017 at 10:28 am

      Hi Chris, congrats on mortgage freedom! I’ve done the same thing, opting for two 5-year variable terms before most recently renewing at the 2-year fixed rate (cheaper than variable this time around).

      • Denis on May 1, 2017 at 5:31 am

        I had a number of 1 year mortgages but went to 4 year term last time as the difference in rates not much and rates were supposed to go up.

  3. Carlos Henao on May 2, 2017 at 12:33 pm

    I strongly disagree with the 10 year mortgage idea. That type of mortgage would have the maximum penalty. Think of it this way: Penalties represent interest the lender could have had if you had stuck with it for the full term. Add 5 years to that calculation and the amount is not pretty.

    10 year mortgages equals maximum hurt. I’ve heard the penalty calculated as high as 10% of outstanding balance.

    Though for those of you who do have that type of mortgage, once you hit the 5 year mark the calculation switches to 3 months interest… lowest possible penalty calculation.

  4. Ed Rempel on May 3, 2017 at 3:26 pm

    Robb,

    Good article!

    One comment. I disagree that there is peace of mind with a 1-year fixed (or even a 5-year fixed). To explain why, look at the various risks and the odds of them happening (based on history):

    1. Risk of a huge interest rate rise where the fixed rate protects you: Less than 1%. (Has not happened even once in the last 70 years.)
    2. Risk of a penalty costing your thousands: At least 40-50%. (About a third of people with a 5-year fixed pay the penalty. Probably higher for 10-year.)
    3. Risks of paying thousands more interest: At least 99%.

    For some reason, many people are scared of an extremely unlikely risk of losing money, but not scared of the likely risks of losing money.

    If you want peace of mind, focus on saving money on your mortgage, so that you can build up some real financial security.

    Ed

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