GoMax content Team
Aug 19, 2010 - 12:14:58 PM
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Why Is Your
"Term" Important?
There's an old saying: "The lowest rate
will save you hundreds, but the wrong term can cost you
thousands."
Put another way: your mortgage term can have a far
greater impact on interest cost than the up-front interest rate. That’s
because your term determines the length of time you're locked into a rate.
That, in turn, affects how long you'll overpay or underpay, relative to
the other available options.
The wrong term can get mighty expensive if interest rates deviate
from your assumptions, or if you need to break your mortgage early.
It therefore pays to make the right choice from the get-go.
Remember: Almost anyone can find a low rate by browsing the
Internet. Picking the right term on the other hand isn't so easy. Take
some time, get good advice, and nail the right term the first time.
Below you'll find bite-sized term reviews to get you started.
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Popular Fixed Terms…
Here's a breakdown of the most common mortgage terms:
1-year Fixed: If rates rise as economists
expect (see: mortgage rate forecast),
then a deeply discounted 1-year term is mathematically not a bad option to
at least consider as an alternative to a variable. At the end of the term,
you can re visit the current market trends and have the flexibility to
adapt your plan. The down side is if rates go up you will be facing an increase in your cost.
2-year Fixed: Rates on two-year terms
aren't currently low enough to warrant much consideration, relative
to a 1- or 3-year fixed.
3-year Fixed: There are currently some
very aggressive pricing packages for 3 year terms that make this
definitely worth a consideration.
As
always, the trade-off with a 3-year term is more risk in years 4 and 5.
But if the price is right, it is a great
option.
The 3 year term also lines
up fairly well with the
US
election and interest rates historically have been in the low half of interest rate
cycles during an election year.
4-year Fixed: At today's rates, 4-year
mortgages are not big sellers unless you plan to break your mortgage in
four years. (Remember, however, that people do refinance every 3.5 years
on average.)
5-year Fixed: Insurance rarely comes
cheap, and five years of rate security can cost you up front but if it
allows you to sleep at night it’s worth the price. If rates rise
more than expected, this conservative play could pay off, but if rates stay low as many predict it could cost you.
Longer Fixed Terms…
7-year Fixed: The spread
between 5- and 7-year terms is about one point, which makes seven year
terms almost useless from a mathematical perspective. If you’re that
concerned about risk, take a 10-year term for 40 basis points
more, and get three more years of rate protection.
10-year Fixed: The decade
mortgage is now available just above 5%. Some consider that a pittance for
10 years of knowing your payments. What’s more, some 10-year terms let
you out after 5 years without paying a dreaded IRD penalty. On the other hand, for a 10-year to prevail,
5-year fixed rates would have to soar over 3.64 percentage points by
the time your 5-year term matured. We haven't seen any
reputable analysts calling on long-term rates to rise that much
in the next 60 months. What's more, history has shown that 9 out of 10
times, 10-year fixed terms cost more than consecutive 5-year fixed
terms.
Variable Terms…
5-year Closed Variable: Don't let "prime
- 0.20%" advertised
bank rates fool you there are better rates today
just ask your mortgage professional.
Remember this though: Prime rate will continue to
climb but the unknown is at what pace. Most people taking variables are betting that prime won't
exceed 5% in the next five years. (5% prime is the rough
"breakeven" point between today's variable and 5-year fixed terms).
If you plan to convert your variable to a fixed rate, taking a
3-year fixed term from the outset might be a better plan. This way you won't
need to worry about market timing, and you won't be stuck with your lender's conversion rate
when locking in.
3-year Variable: 3-year terms let you
renegotiate sooner--which is good if you might need to break your mortgage
in 3 years, or if you think variable discounts will improve in 36 months. Traditionally
you don’t get as aggressive a rate on the 3 year variable as you would get
on the 5 year.
1-year Variable: With 1-year fixed rates
below 1-year variable rates, why bother with a 1-year variable?
5-year Capped Variable: Again you are paying
a large premium for security, I think there are better options.
5-year Open Variable: Open mortgages are
temporary solutions, and you'll pay a premium for their flexibility.
Remember, closed variables are portable, and they only have a 3-month
interest penalty. Even if you break a closed variable in seven
months and pay the penalty, it's usually cheaper than taking
an open...at today's rates anyhow.
Variable payment options:Even though your rate is going to
fluctuate in a variable mortgage, it does not mean that your payment has
to?
One of the most powerful money
saving systems I have ever used is as simple as fixing your variable rate
mortgage payment at or even a little higher than the 5 year fixed rate
equivalent.
By doing so you take
out most of the risk and stress of a conventional variable mortgage.
For example if your minimum payment on a
variable mortgage was $425 per month but instead you set your payment at
the 5 year fixed rate $525 per month, the additional $100 per month would
go towards paying down your mortgage faster saving you thousand in
interest.
Now, even if the variable
rates did climb higher than the original 5 year fixed rate, you would be
paying interest on a smaller amount of money.
The net savings can be huge and it’s
simple and definitely worth considering.
In
Summary
The term you choose is very important and when choosing the term
you must take into account your future plans and needs as well as your appetite
for risk. Some people go to Vegas and
bet the farm while others invest in T Bills and GIC’s, so the term and product
need to match your personality as well. There
is no one product fits all solution because everyone is different and has
different needs and wants so it is important to deal with a mortgage
professional that can assist you in getting the best mortgage for your unique
situation.
The Disclaimer: There
are a million and one exceptions to everything above and market conditions
change almost daily. Therefore, do yourself a favour, and consult a
mortgage professional for a current comparison of the options. Remember,
these opinions are just that. They are
not recommendations or
advice. Qualifying is always contingent upon approved credit. All information
is based on present market conditions, current economist forecasts (we do not
predict rates), and today's rates and expectations--each of which may change
drastically without notice!
