15 November 2010
As the professionals say, “The lowest rate will save you hundreds, but the wrong term can cost you thousands.” In other words, your mortgage term can have a far greater impact on interest cost than the interest rate itself. The deal is that the wrong term can get really expensive if interest rates change in the way you didn’t expect.
It’s easy to find a good interest rate. But picking the right term can become a problem. Don’t hurry and take some time, consult your mortgage advisor and see what’s best for you. Here is a small term review which can help you make a decision.
• 1-year Fixed: In case of a rate hike (which economists predict) 1-year fixed is a good alternative to a variable. Moreover, you can move into another 1-year or switch into a variable rate if it’s better for you.
• 2-year Fixed: The rates are quite low, so it can be even slightly more attractive than variable and 1-year fixed rates.
• 3-year Fixed: This one is very attractive since the rates are under 3%. One of the best mortgage strategies for the future 5 years may be the following: a three-year fixed followed by two one-year terms.
• 4-year Fixed: With today’s rates, 4-year mortgages might be a good alternative to 5 years (remember, that people refinance every 3.5 years on average).
• 5-year Fixed: This term is the most popular in Canada. Moreover, the government restrictions on variable-rate qualification have made it more so. Today 5-year fixed rates are historically low.
Longer Fixed Terms
• 7-year Fixed: The spread between 5- and 7-year terms is over 120bps (1.20%), so it’s quite pointless to take it. If you worry about the risk, you may take a 10-year term for 30bps (0.30%) more and get three more years of rate guarantee.
• 10-year Fixed: Today it’s available just under 5%. Some people believe it’s almost nothing for 10 years of knowing your payments. In addition to it, 10-year terms let you out after 5 years without paying IRD penalty. But according to historical data, 9 out of 10 times 10-year fixed terms cost more than consecutive 5-year fixed terms.
• 5-year Closed Variable: Prime – 0.80% is a standard for 5-year variable rates again. Those who choose variables today don’t believe prime rate will go higher significantly. They think the history repeats itself. (Historically, 77% of the time variable rates have prevailed over 5-year fixed rates).
But still, every major economist predicts prime rate to continue increasing starting 2nd half of next year.
• 3-year Variable: Prime-0.85% can be very appealing.The benefit here is that 3-year terms let you renegotiate sooner.
• 1-year Variable: With today’s 1-year fixed rates below 1-year variable rates, it’s pointless to choose 1-year variables.
• 5-year Capped Variable: There’s not much benefit in it.
• 5-year Open Variable: In case of open mortgages you’ll overpay for their flexibility. Meanwhile, closed variables are portable, and they only have a 3-month interest penalty. So, in the end, even if you break a closed variable in 180 days and pay the penalty, it’s still cheaper than taking an open.
Other Terms and Features
• 5-year Cash Back Down Payment: The majority of borrowers think it’s a desperate decision to take it. If you can’t put down 5% – rent and build up a down payment.
• 5-year No-Frills: No-frills mortgages can really save you 20bps (0.20%), but you’ll give up pre-payment privileges and the ability to switch or refinance elsewhere mid-term. Moreover, sometimes you’ll have to:
o pay “reinvestment” fees if you break early
o pay higher penalties
As a result, you’ll save only $26 a month on a $250,000 mortgage.
• Readvanceables: It’s a good choice if you have 20%+ equity. But remember, that in this case you can’t switch lenders without paying legal fees.
• Open HELOC: HELOCs are priced at least 125bps (1.25%) above closed variable mortgages. So if you’re not planning to pay it off quickly, or you don’t need interest-only payments, it’s not the best variant for you. If you’re going to borrow a large amount and pay off less than 25% each year, it may be more profitable to get a readvanceable closed variable or 1-year fixed instead. If you still choose a HELOC, please, try to avoid those lenders who still offer you prime + 1.00%.
• Hybrids: A hybrid mortgage consists of fixed and variable parts (sometimes the terms can be also different). It’s best to choose hybrids that contain the same terms (for example, a 5-year variable and a 5-year fixed). If you’re considering a hyrbid, you may be also interested in a 3-year term.
Of course, it’s always necessary to understand that market trends can change in a minute, so it’s recommended to consult your mortgage broker in order to find the best variant exactly for you.