Getting a mortgage is likely one of the largest debts you will take on in your lifetime. Picking the right mortgage term, type and length is a crucial step in the financing process. Whether it’s your first or fourth home, you can maximize your homeowner happiness by choosing a mortgage term that is affordable and suits your lifestyle, while also helping you achieve your financial goals. This week, I want to quickly summarize the variety of mortgage terms available and the features each offer.
To begin, a quick note on the difference between fixed and variable interest rates. Fixed mortgage rates are characterized by an unchanging fixed interest rate and mortgage payments for the full length of the term you choose and also features 2 types of potential payout penalties. Should you break your fixed term early, you will be charged the higher of 3 months interest or the interest rate differential. Variable rate mortgage terms on the other hand include an interest rate and mortgage payments that could fluctuate with any changes in the Prime Rate depending on the lender. To break a variable term early you usually only have to pay 3 months interest though do double check the fine print on your mortgage commitment to review the exact potential payout penalty calculations with the lender.
7 and 10 year terms
These terms are perfect for those who want above all, minimal mortgage maintenance and a long payment amount guarantee. Not all lenders offer these term lengths and the ones who do are advertising the rates at 3.99% or higher which means they are not for everyone given the rates for the shorter terms are quite a bit lower. One of the deterrents with these longer terms is the payout penalties should you break the term early as the lost interest rate differential could be quite high depending on the lender.
This is the term chosen by majority of my clients over the many years I have been underwriting mortgages and it is a first-time homebuyer favorite. The 5 year terms are available under both a fixed as well as a closed or open variable rate. If you take the fixed rate option, this is the most affordable option as you can still qualify at the contract rate which may be around 2.99% today with some lenders. If you choose a variable term you have to qualify at the benchmark rate set by the Bank of Canada which is 4.99% on May 6/14 which means some borrowers may only be able to qualify for what they want to buy under the 5 year fixed rate option.
This term seems to fly under the radar with most borrowers and I believe it’s for the simple reason that the 4 year rate is often the same as what is being offered for the 5 year term, so why not take the extra year. I have only ever seen a 4-year fixed term and not a 4-year variable or open term. The downside to this rate offering is one has to qualify for the new mortgage at the benchmark rate rather than the contract rate you actually are getting the mortgage at which means not all people will qualify for the 4 year term .
You’ve heard of the 7-year itch, with homeowners it’s the 3-year itch. After year 3 of the mortgage is when the highest percentage of homeowners will make changes to their mortgage. Whether it’s to refinance to access home equity, revisit your mortgage rate, or to sell and move to a new place. The 3-year term is great if you’re undecided on which term is best as it seems to be the happy medium between all the term offerings mentioned here. Majority of lenders offer this term length and you can find both fixed and variable rate offerings, though, again, you must qualify at the benchmark rate of 4.99% and not the contract rate.
The 24-month term is great if you need to do some extensive credit improvement and want to eventually change lenders to one with a lower rate or maybe want to make a change for another reason within that time period. Or perhaps you just want to pay a low interest rate. Three years may seem like too long for you and if you have to go the alternative lender route due to some financial issues, the 2 year term may be best as that is usually how long it takes to repair most credit issues. Again, the government benchmark rate is usually applicable in qualifying.
A year goes by pretty fast, so this short term is great for quick finance fixes or minor credit repairs. Best rates offered are around the 2.75% mark. While the low rate make it appealing, it still features a payout penalty if you break the term prior to the end of that year. And again, one must qualify at the benchmark rate instead of the contract rate, so a shorter term could affect your maximum borrowing power.
If you break a closed term early, you will most likely have a payout penalty. This isn’t great if you are financing a renovation or doing a quick property flip. Most mortgage terms are closed unless specifically documented that it is an open term. The benefit of an open term is you don’t have a payout penalty if you break the term early and in turn for that flexibility, most open terms come with significantly higher interest rates. I most often see only 6 month and 1-year open terms as the longer fixed term offerings tend to be only available as closed. Again, the benchmark qualifying rate is applicable for this term.
Home Equity Line of Credit
Like an open term, a line of credit features no payout penalty. It also offers interest only payments and is re-usable once you pay down the balance. The home equity line of credit, also known as a HELOC has a variable rate and the maximum amount you can borrow is 65% of the home value unless you specifically ask the lender if they have a “bundle” product which would include a portion of the borrowings as a mortgage. With interest only minimum payments, some find it difficult to reduce the principal so make sure you have a strong repayment plan in place. And once again, the benchmark rate is used by the lenders on the approved limit to determine eligibility for this product.
Picking the perfect mortgage can be stressful so your first step is to have an in-depth conversation with your mortgage professional about a financing solution that fits your needs.