Getting a mortgage is likely one of the largest debts a borrower will take on in a lifetime and choosing the right mortgage term, type and length is a crucial step in the financing process whether it’s your first or fourth home. Maximize homeowner happiness by choosing a mortgage term that is affordable and suits your lifestyle, while also helping you to 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 a set interest rate and the same mortgage payments for the full length of the term you choose. Fixed rate mortgage terms feature 2 types of potential payout penalties should you break your fixed term early, the higher of 3 months interest or the interest rate differential. Variable rate mortgage terms come with an interest rate and mortgage payment that could fluctuate with any changes in the Prime Rate. Most lenders will only charge a 3 months interest penalty if you’re breaking a variable term early, double check the exact payout penalty calculation with the lender as it’s very dependent on timing.
Keep reading for a breakdown of the mortgage term length options available to borrowers.
7 and 10-year terms
These terms are perfect for those who want above all, minimal mortgage maintenance and an extended payment amount guarantee. Not all lenders offer these term lengths and the ones who do are advertising the rates at 3.39- 3.79% 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. *Note* some lenders will include a clause that the mortgage is fully open after the first 5 years of the term.
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 favourite. The 5-year terms are available under both a fixed rate term, as well as a closed or open variable rate term. If you choose the fixed rate option, this is the most affordable option as you can still qualify at the contract rate, which may be around 2.59% today with some lenders. If you choose a variable term you have to qualify at the 4.64%* benchmark rate set by the Bank of Canada. This means some borrowers may be able to qualify for a higher mortgage amount if they select a fixed rate instead of a variable.
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 terms, so why not take the extra year. The downside to this rate offering is the borrower 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 borrowers 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 the 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 of the term offerings mentioned here. The 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 4.64% and not the contract rate.
The 24-month term is great if you need to do some extensive credit improvement and you want to eventually change lenders to one with a lower rate, or more favourable terms. Three years may seem like too long and if you have to go the alternative lender route due to some financial issues, the 2 year term may be best, though 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 2.19% mark. While the low rate makes 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. 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 fixed open terms and again, the benchmark rate is applicable for qualifying when it comes to open terms.
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 as 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 available. This means a small portion of the borrowings has to be as a mortgage while the remainder can be as a line of credit or a credit card with interest only minimum payments. Once again, the lenders assess eligibility and approved limit for this product by using the benchmark rate.
Picking the perfect mortgage can be stressful and once you’ve set financial goals and prioritized your budget; the next step is to have an in-depth conversation with your mortgage professional about a financing solution that fits your needs. Take that opportunity to explore all the features and benefits to each product and make an educated decision about picking the perfect mortgage term.
*Benchmark rate as of Feb 15, 2016.