A common question I hear from mortgage clients is how to decide between a shorter term mortgage and a longer term mortgage. Here's a response to one of my recent mortgage customers.Regarding term, take a term today based on your expectation of available rates at renewal time. This is called your "renewal risk." For example, at the time of writing...
- An ultra competitive 2 year rate today is 2.34%* ... question to ask is what will the rate be on a 3 year term at renewal for an apples-to-apples comparison with a 5-year fixed rate at 2.94%. The break even point is 3.29%, so you'd be better off today with a 5 year rate if you have to renew in 2 years at a rate higher than 3.29%
- An ultra-competitive 3 year rate today is 2.59%*, so you would need to renew for 2 years at 3.53% or less to make the 3 year term worthwhile. (PS - I use a fancy spreadsheet to do the math!)
- Keep in mind, no one really knows where interest rates might be. Personally, I just took a 2.94% for 5 years myself. Set and forget...I know what my payment is for next 5 years, and I see it as a coin toss.
- Alternately, if you want to play the short game and fret about the market, you can take a variable rate mortgage for now and lock-in a fixed rate if you start to get concerned. A 5-year variable rate today might be Prime (mortgage) Rate less 0.50%, so 2.50%, maybe you can get it for a touch less. (* note: some first time borrowers get confused or focused on rate when the REAL GOAL is to get approved by a lender. Ultra-competive rate might not be offered for your employment and/or credit profile.)
- In today's market, I feel 10 year terms are generally noncompetitive (4.29% at present), paying far more today for the "potential" that rates might rise a lot. Doing the 10 years at 4.29 vs 5 years at 2.94 math, your break even is 6.01% for renewal, meaning a 10 year contract would only make sense if you felt 5-year fixed rates would rise above 6% by renewal time.
So that is how to do the analysis. If you need help, please contact me.
FYI, one thing in today's market (2014) is the old "rules of thumb" about short vs long term don't necessarily hold true. Rates have never been this low ever. This is a function of the aftermath of a world financial crisis. "Normal" mortgage rates have always been in the 4.5% to 6.5% range. Today, to qualify for a term under 5 years or a variable rate mortgage, the Government of Canada sets a benchmark qualifying rate, currently at 4.79%, meaning you have to be able to afford the mortgage if rates rise to this level - a stress test so to speak..jpg)
