Playing the Interest Rate Chicken Game with your Term

5 Year vs. 10 Year Mortgages – Does it Matter? 

The best and worst thing about becoming a mortgage broker is the training. On one side, getting your license involves doing a lot of math with specialized calculators and an understanding of legalities and other professions surrounding purchasing real estate. The advent of the Internet has made the former redundant and while it's nice to know how a real estate appraiser uses comparable sales to determine a home's net worth, it isn't up to me to actually do the appraisal.

Your friendly mortgage broker learns a lot through osmosis and trial and error and trying again. Most of my education has come after I received my license. Understanding credit reports and lender's various positions regarding credit scores, 'high-risk' locations for lenders, purchasing your parents' house, sweat equity as a down payment, all matters not covered in the How-To-Brokerage textbook. 

I encourage variable mortgages if you qualify. Historically, they are the best when it comes to paying down your principal. But if you qualify is also another interesting hurdle (if you love math). You need to prove your income coming in is sufficient to cover not only all your current debts (think credit cards, car loans, other properties) but also the cost of a mortgage payment will leave you with room to breathe financially. We in the business call it the Total Debt Servicing Ratio or TDS for short and we aim for less than 40% TDS.  

Next, interest rate savings come as you consider your term and amortization; lenders love terms; the longer the better (for them). If you want to keep the interest you pay over the long term the least amount possible you might want to play the Interest Rate Chicken Game and just get 1 or 2 year term. The caveat being you have to qualify (shop) again after the term is up and nobody truly knows what the interest rate will be - one can only make an educated guess. 

Also of note - if you shorten your Amortization period, your payments will also increase as you are paying off more principal in a shorter amount of time. 

Here's an example of the Interest Rate Chicken Game; 

According to my website, a 1 year interest rate is 2.19% vs. 2.49% for five years *March 2016 for you future blog reader/time travelers. 

Doing some quick math - 

Mortgage Amount   $350,000

Term/Amortization                    1/25         5/25

Interest Rate                           2.19%        2.49%

Balance at end of Term   $340,866.21     $297,739.19

Monthly Payments              $1514.37        $1566.14

Savings                         $51.77/month       $621.44/year

As you can see, short-terms can bring you some savings that you may not have considered. But here's the Chicken part - will interest rates stay the same next year? Will your lender want to renew the mortgage on the same terms? Perhaps your financial circumstances might change. Perhaps you will want to move. All things to consider and to discuss with your mortgage broker. 

Nobody calls me Chicken!

If you don't like to watch or worry about crash of the real estate market (which is a weekly subject on any newsfeed for the last few years), then you might want to just lock in to a 5 or 10 year mortgage commitment and forget about it.   

So, 1, 2, 5, 10 year mortgage commitment.... which one works for you?

The reality is that each mortgage term has various strengths and weaknesses be it the 1,3,5 or 10 year rate. 

With 5 year fixed rate mortgages ranging around the 2.5%-4.6% rate on various banking institutions and 3.85%-6.2%* for 10 years, the spread between the 10 year fixed mortgage and the 5 year fixed rate mortgage is a very real discussion that you and your mortgage planner should have. *again - rates as of March 2016.

That's my line...

Your mortgage broker should take the time to evaluate your personal goals, financial limits and any family commitments you might have. From there, they will likely have a better idea of what kind of mortgage term and product they think fits best for you.

For an example of a mortgage strategy – let’s consider a 10 year fixed rate mortgage…

The current 10 year fixed rate mortgage product certainly offers a lot of benefits to Canadians looking to renew their mortgage.. This low rate-long term strategy offers Canadians some excellent benefits:

• Long term predictability; you’ll know your mortgage payments for the next ten years won’t change. If you’ve budgeted or allotted $1000 per month for your mortgage, you know that number won’t change for the next decade.

• A ‘full-package’ mortgage; you’ve likely have heard about the stripped down ‘no-frills’ mortgage offers from some of the big banks. The 10 year fixed rate mortgage products in today’s markets offer the large pre-payment privileges Canadians home come to expect, along with portability options and amortization periods longer than 25 years.

• After the 5 year mark in your 10 year fixed rate mortgage, the penalty to break your mortgage is only equal to three months’ interest, this is a relatively reasonable amount. 

The benefit of security & predictability makes the 10 year fixed rate mortgage product an excellent mortgage product for certain Canadians in scenarios:

• The purchase of a other properties or investments; being able to plan your mortgage payments for the next 10 years at 3.69% allows you to lay out a strong investment plan for your future.

• Fixed or stable incomes – on a fixed income you typically look to avoid the unknown and likely cherish the value of predictability and security. You’re also provided protection from any interest rate volatility.

An interesting mortgage strategy is to take a mortgage product like the 5 year fixed rate mortgage at 2.89% and to make payments as if you were still in a mortgage term at 5.2% interest. In this scenario, the mortgage strategy dictates that you keep your payments at the same amount as they were during your term at 5.2% interest.

By paying the same amount but at a lower interest rate, your payments now work more against your mortgage principal. This will shave years off of your mortgage. It is a strategy that helps you get to zero faster.the same as if you are making extra payments. The banks won't suggest this to you as it works against their bottom line, which is charging you interest for as long as you owe them money.

In no way is the point of this post to say that the 10 year fixed rate mortgage is the perfect fit for every Canadian. Financial circumstances, future family growth or job opportunities give good reason to look into shorter terms with smaller pay out penalties. What is important is for you and your mortgage broker to have a discussion regarding your thoughts on the length of your term and amortization.

Never count your money as your sitting at the table - Kenny Rogers Chicken