Different times call for different mortgages. My current recommendation for (specifically qualified) buyers is often a two-year fixed. This is what ~70 per cent of my clients are already in at the moment, if not a variable. It boils down to rate and flexibility.
Why fixed instead of variable?
Variable rate discounts have not been as kind over the past few years, although as of late they have moved in our favour from 0.20% to ~0.45% below prime, yielding rates around 2.25 per cent. With 2-year fixed, some lenders are offering rates just a touch lower, 2.24% for instance.
Why consider the two year?
For myself, the coming two years seem predictable, I cannot see interest rates moving sharply upwards within the next two years. The new federal government is committed to investing in infrastructure (i.e., borrowing more money themselves) in order to hit the gas pedal on the economy, so it’s unlikely that the Bank of Canada will put its foot on the brake by raising interest rates in the next 18 to 24 months.
Beyond that, my crystal ball is murkier.
But isn’t it safer to just lock in to a five-year mortgage at today’s incredibly low rates? Why go to the hassle of having to renew in two years?
Suppose rates start to rise in year four. With most five-year fixed mortgages you are stuck until renewal, unable to early renew until the final 120 days of the term. By then, if rates were rising through year four you may not be so happy with the new renewal rate options. On the other hand, a two-year commitment is a great placeholder, and rates will likely still be quite low come renewal time (technically 18-20 months depending on the lenders early renewal allowance). And if rates are starting to inch up at that point, perhaps then it will then make sense to renew for a longer term or consider the variable.
However, there is more to be wary of than rising interest rates.
Consider these startling facts:
- Six out of ten mortgages are broken an average of 38 months in. People plan to stay in their home for the full five years of the mortgage and beyond, but then things change. Things happen, both good and bad. Divorce, marriage, kids arriving, kids departing, job transfers & promotions, an offer on the property that you cannot refuse… and now you want out of the mortgage. The trouble is, depending on which institution the 5 year mortgage is with, the pre-payment penalties can be as high as 4.5 per cent of the balance. ($4,500.00 per $100,000 of mortgage balance)
- It costs nine times more to get out of a five-year fixed (bank) mortgage than a two-year fixed or a variable. Typically the prepayment penalty for the shorter term or variable is about 0.5 per cent on the balance (just $500.00 per 100,000 of mortgage balance). And the term on a two-year might even be short enough to wait out, avoiding any penalties at all.
But if your mortgage is portable, can’t you just take it with you with no penalties?
Good point. The trouble arises in a superheated markets when it’s not that easy to buy. As a buyer, you may be outbid time after time, or other buyers write (foolishly) subject free offers. And if you sell your home before you buy another one, you could go ninety days without making a purchase. After ninety days your mortgage is no longer portable. Hello 4.5 per cent pre-payment penalty.
The five-year fixed mortgage can be a safe-ish way to go, but it needs to be placed with the right lender, one with flexible prepayment penalty policies and flexible early renewal policies.
There is much more than just the rate itself to review.
Thank you
Dustan Woodhouse