Selecting the right mortgage term can be a challenging proposition for even the savviest of homebuyers, as terms typically range from six months up to 10 years.
“Term” refers to the length of a mortgage contract. There is such an intense focus on the interest rate that the mortgage term is often overlooked. When you select a closed mortgage with the wrong term, you will be paying that rate until your mortgage comes up for renewal, unless you pay the penalty to break your mortgage. If you end up selecting a “no frills” mortgage with a lower interest rate with major restrictions, you will be stuck with the lender until the end of the term, unless you sell the property.
The most common option is the five-year fixed term. The reason is that with the recent mortgage rule changes, the qualifying interest rate for all mortgages with variable terms and with fixed terms of less than five years is the greater of the contractual mortgage interest rate or the five-year Benchmark Qualifying Rate (currently 4.64 per cent). For example, if you opt for a five-year variable rate, you will pay prime (currently 2.85 per cent) minus 0.65, but you will have to qualify at the Benchmark Qualifying Rate of 4.64 per cent. For fixed-rate mortgages where the term is five years or more, the qualifying interest rate is the contract interest rate.
This is why it is important to understand the mortgage terms and what they mean in dollars and cents, so you can save the most money and choose the term that is best suited to your specific needs. Typically, long-term rates refer to four-, five-, seven- or 10-year fixed terms, while short terms include one-, two-, or three-year fixed terms and variable mortgages.
The first consideration when comparing various mortgage terms is to understand that a longer term generally means a higher corresponding interest rate, and a shorter term generally means a lower corresponding interest rate. While this generalization may lead you to believe that a shorter term is the preferred option, this isn’t always the case. Sometimes there are other factors in either the financial markets or your own life that you will have to take into consideration when selecting the length of your mortgage term.
If paying your mortgage each month places you close to the edge of your financial comfort zone, you may want to opt for a longer mortgage term, such as five or 10 years, so that you can ensure you will be able to afford your mortgage payments should interest rates increase.
By the end of a five- or 10-year mortgage term, most buyers are in a better financial situation, have a lower outstanding principal balance and, should interest rates have risen throughout the course of the term, will be able to afford higher mortgage payments.
If you are shopping for a mortgage for an investment property, you will likely want to consider choosing a longer mortgage term – depending, of course, on your overall plan. This will allow you to know that the mortgage payments on the property will be steady for a long time and enable you to more accurately project your future income from the property.
As well, if you know you will not be staying in the same home for the next five or 10 years, opting for a shorter term can save you significant fees when it comes to early payout penalties. If you are unable to qualify for a term less than five years, then select a mortgage with the best terms and options, such as pre-payment privileges and a portability option.
Choosing the right mortgage term is an important decision for each individual. By understanding your personal financial situation and your tolerance for risk, a mortgage expert can assist you in choosing the mortgage term that will work best for your situation.