On the face of it, choosing a mortgage term seems to be one of the smallest decisions that you’ll make when getting your mortgage. After all, the lender, interest rate, and amortization period, and sheer size of the loan itself appear to have much more of an impact on the bottom line than your mortgage term. The term does, however, play a big impact on what you’ll pay for your mortgage overall, as well as give you a short term outlook on your long term mortgage commitment.
Term vs amortization
First, let’s clarify what your mortgage term is. Your mortgage term is not the entire length of your mortgage. That is known as the amortization period, which is the period of time that you choose for your mortgage to be paid off completely (have a look at our mortgage calculator
and you can see the difference that you’ll pay in interest and payments with different amortization periods).
Your mortgage term, however, is the period of time that the terms and conditions of your mortgage are agreed upon between you and your lender. So if you’re getting a mortgage with a fixed rate, your interest rate, payments, and conditions are set for that agreed-upon period of time, or term. If you’re getting a mortgage with a variable rate, the amount of interest you’ll pay will vary and the conditions will be the same for that term (although your payments may or may not stay the same, depending on your contract). Unlike mortgages in the U.S., where you can have a term that’s the same as the entire length of your amortization period, mortgage terms in Canada range from six months to 10 years. Although it would seem that people would like to lock in their current mortgage rates and conditions for as long as possible during periods of time when interest rates are low, interest rates differ based on the length of the term. Eight-, nine- and 10-year mortgage terms, for example, can be anywhere from one to five per cent higher than one- to five-year mortgage terms.
Relationship between terms and rates
Terms are also tied very closely to interest rates. Longer terms tend to carry higher interest rates, as you’re paying for that stability for the extra period of time. Geoff Lee, president of GLM Mortgage Group in Vancouver, says that the regulations that changed in October have changed the game a bit when it comes to the terms people choose. Before, it was harder to qualify for shorter term mortgages whereas now, depending on the down payment and the type of lender, it’s just as difficult to qualify for a longer term mortgage as it is for a shorter term mortgage.
“A the end of the day, the new rules handcuff people of their buying power by 20 to 25 per cent,” Lee says. “So now what has happened is, obviously that had an effect, but now they just have more options as far as if they want to choose a variable or a fixed rate, whereas in the past, they might not have had that option.”
Being forced to renegotiate the terms and interest rates over the life of your mortgage can seem like a hassle, especially when you have a low interest rate and want to lock it in. But keep in mind that this is only the case in a low interest rate environment; when interest rates are high and/or trending downward, the benefit to having shorter mortgage terms is that you can take advantage of lower interest rates, which you would not be able to do with a fixed long-term mortgage unless you pay the penalties for breaking your mortgage – and, as Lee says, statistically, seven out of 10 people are going to break their mortgage before the end of the contracted term
A majority of Canadians continue to choose fixed rate mortgages, five-year fixed-rate mortgages in particular. This is understandable for a number of reasons: first, first-time home buyers in particular often want the certainty that a fixed-rate mortgage can provide as they navigate through the waters of learning the true costs of owning a home, including the cost of heating and cooling, home maintenance, and repair. Even veteran buyers like five-year mortgage products. But just because a majority of people purchase a particular product doesn’t mean that it’s right in the majority of circumstances.
“A mortgage is like a personality,” Lee says “If you’re just getting attracted by the rate and not understanding the personality of it, then seven out of 10 are going to be disappointed when they have to break that mortgage – because, statistically speaking, seven out of 10 are going to break it. So the personality of your mortgage is as important as the rate.”
So if you’re not just looking at rates alone, how do you know what mortgage term is best for you?
How to choose?
There are two parts to choosing the correct mortgage term: your current and projected financial state and life circumstances, and the current and projected outlook for interest rates.
Whether rates are going to go up or down over a long period of time is hard for experts to predict, but it’s even more difficult for the average homeowner. Ask your mortgage broker for his/her opinion and take it into account, but it’s going to be easier to predict your financial state and life circumstances over the course of any given term than make a case study of the history of interest rates. Nothing in life is certain (apart from death and taxes, as the saying goes), so while it may be easy to say that you (and your partner, if you’re buying a home with someone else) don’t expect much to change over the next, say, five years, there are a lot of changes that people take for granted without extensive planning.
One change for many people, especially first-time buyers, is the expansion of their families. Not only is there the maternity and/or parental leave to account for, but the cost of childcare and/or loss of income if one partner decides to become the primary caregiver. Another big change could be taking a sabbatical or other long-term leave from your place of employment that may mean a reduction in income. Even though you may have savings to fall back on in the event that your household loses income to ensure that you’re able to carry the mortgage, you also have to think about the fact that a change in life and/or financial circumstances means that you may not qualify for the same mortgage in three years as you would today. That’s not always a bad thing; If you have poor credit and expect it to improve sooner rather than later, for example, then you might want a shorter term so that you can take advantage of a better interest rate as soon as possible. Another reason you might opt for a shorter term as opposed to a longer one is if you’re buying a house now but planning on selling it within a short period of time. If that’s the case, and you don’t plan on moving your mortgage to your new property, then a shorter term may be more attractive.
If you are expecting some upheavals in the near future, whether it’s as seemingly minor as getting a new car or going back to school, then you may want to get a longer term for your mortgage so you can deal with those issues first before deciding committing to a long-term mortgage plan. A long term mortgage is anywhere from four to 10 years, and although you’re going to pay more for it, there’s nothing wrong with playing it safe and knowing exactly what your monthly payments are going to be for a long period of time.
There's also always the option of getting a convertible mortgage, one that starts as a stort-term mortgage but can be extended to a longer term. Once the mortgage is converted or extended, the interest rate will change to the rate the lender is offering for the longer term.
If you’re having a difficult time deciding – and who could blame you? – reach out to a mortgage broker, who can help you price out scenarios based on current interest rates and the size if the mortgage in question, in addition to helping ask some tough questions about your financial future.
Are you looking to invest in property? If you like, we can get one of our mortgage experts to tell you exactly how much you can afford to borrow, which is the best mortgage for you or how much they could save you right now if you have an existing mortgage. Click here to get help choosing the best mortgage rate