Mortgage Term Defined
Term refers to how many years you are contracted or tied to a particular lender before you need to renew or renegotiate your mortgage or pay it off in full. Term can also be an element to a mortgage contract, such as in terms and conditions. They are both important and interrelated.
- During the Term, the mortgage company or bank is your lender and you are their customer.
- Your mortgage contract contains the terms and conditions that you agree to when you are approved and accept a lender's mortgage commitment letter. You further acknowledge the mortgage contract terms when you sign papers at the lawyer's office. As always, there is the "fine print" that not all of us read or take the time to understand. Pay particular attention to mortgage break/payout penalties and fees.
- Lenders have customer service departments or retail branch locations that can answer questions for you, help you make extra payments, change your payment date, get balances owing, etc.
- Within about 4 months of your mortgage term ending (the "maturity date"), you will need to renew or renegotiate with the same lender for a further term or switch to a different lender, in which case the current lender is paid out by new mortgage funds coming in from the next lender.
- If you want to move to a different house mid-Term, most lenders allow you to "port" or transfer the remaining mortgage balance to the next property provided it is in a similar lending category (small house to a bigger house, for example) and provided that *you* can also re-qualify for your mortgage. Pay attention to the terms regarding 'porting' - some of the rules are so tight that you may be forced to break the contract instead.
- If your mortgage contract no longer meets your needs and you are mid-term, one of the contract terms will outline the penalty you will have to pay to break the mortgage contract. These mid-term break penalties can be hefty (in the tens of thousands!) and the payout penalty calculation varies from lender to lender.
What is the correct mortgage Term?
If you pick a closed mortgage with the wrong Term and/or the wrong lender, you are either stuck until maturity or you discover quickly how expensive it can be to break the contract, or worse, you can't even leave the lender unless you sell the property. I need to reiterate, do your homework and choose wisely from the start.
It is important to know that some well-known banks have downright nasty pay-out penalty formulas, and these penalties in aggregate form a significant chunk of their annual profits because they know that on average, mortgage borrowers make changes to their mortgages every 3 years. Other lenders, what we mortgage brokers call the mono-lines because they only do mortgages, have much fairer calculations. My advice is, all other things being equal, ask about and go with a lender with a fairer payout penalty calculation formula.
I was going to write a long article on nasty payout penalty lenders to discover one of my industry colleagues already had an excellent buyer-beware blog on fixed-rate mortgage penalties. The article illustrates how some well-known lenders have tweaked their penalty formulas to weight heavily in their favour, and that can have a huge impact on the size of your penalty and add to your lifetime cost of having a mortgage if you are not careful.
The reality is, you can only guess at how long before you may need to make significant mortgage changes,and go from there. The strategy is to attempt to increase your options by putting some thought into and being wise about lender choice and term.
Here are some considerations surrounding Term
A shorter fixed-rate term (1-3 years) or a variable rate mortgage might make more sense if flexibility is important:
- There is a reasonable chance that you might sell the property in the next few years
- You might be getting a big chunk of money that you'd like to put against the mortgage
- You think that the direction of interest rates is stable or likely to fall and you can afford to be wrong.
- You think that rates might rise, but not for a couple of years so you want to defer the decision to go for a longer term until just before then.
- You are in a mortgage with a higher-priced Alternative Lender and want to get back to lower-priced traditional mortgage lending in the next 2 or 3 years.
- You may need access to equity in a few years, perhaps to start a business or pay for an education.
- Your relationship with your spouse or partner is new or unstable, and the possibility of a breakdown exists.
A longer fixed-rate term (4-10) years might make more sense if...
- You are just starting out and need a longer term to stabilize your earnings and establish some savings, and simply can't afford the risk of a big jump in your mortgage payments any time soon.
- You think rates are likely on the rise and short-term rates are hence too risky.
- Stable payments help with cash flow planning, say on a rental property
- There's a chance your household earnings could drop (start a business, maternity leave, retirement, etc.)
- You're in your dream home and planning to keep forever.
- The maturity coincides with some life event where a change will likely happen (ex. kids leave home, move to west coast)
A note regarding the popular 5-year fixed-rate mortgage. It used to be that the 5-year-fixed was the easiest to qualify for, but rules have changed since then. However, it remains one of the most competitive categories by far for aggressive (discounted) lender offers, so often it is the cheapest longer-term offering. That being said, from time-to-time lenders are offering specials in other terms that could be very attractive for your situation and worth a look. How does one compare?
There is a complex mortgage calculation called the Long vs Short where one determines what break-even renewal interest rate would make a longer-term mortgage (say 5yr) more attractive than a shorter-term mortgage (say 3yr) with a renewal for a further 2 years. Ask me if you need help.