(Ottawa) With mortgage rates at their highest levels in more than a decade, homeowners and potential buyers tend to focus on getting the best rate. However, experts warn that another important element of mortgage loans should not be forgotten: the length of the term.
Samantha Brookes, founder and CEO of Mortgages of Canada, says that before the Bank of Canada started raising interest rates last year, a five-year loan was the norm for most homebuyers. However, that has changed: people are now shortening that duration in the hope that interest rates will come down in the coming years.
“It makes sense because if the Bank of Canada starts cutting rates, say next year, and you’re in a three-year [contract], you only have two years left,” she said.
“You break your mortgage, you have a two-year penalty, but your interest rates are much lower and your payments are more affordable. This is why people are opting for the shorter term mortgage right now. »
The “term” of a fixed rate mortgage is the length of the contract with a fixed interest rate on a loan. At the end of the term, if the loan is not fully repaid, you must renew your mortgage for a new term at the prevailing rates. This duration is different from the amortization period, which is rather the total time required to pay off the loan.
Mortgage rates rose steadily as the Bank of Canada raised its benchmark interest rate target. The central bank’s policy rate, which was 0.25% at the start of last year, is now 4.75%.
According to data compiled by rate-tracking website Ratehub.ca, five-year discount mortgage rates in Canada are at their highest level since the start of 2009. five years ago are now rolling over their loan at higher rates than when they bought their home.
In its Spring Residential Mortgage Report, the Canada Mortgage and Housing Corporation (CMHC) reported that fixed-rate loans with terms of five years or longer accounted for just 13% of new mortgages and renewed in January of this year, while those of one to three years accounted for 36%.
In January 2020, before the pandemic, fixed rate mortgages of five years or more accounted for 46% of mortgages.
Meanwhile, variable rate mortgages accounted for just 16.7% of new and renewed mortgages in January 2023, down from 56.9% in January 2022.
Choosing a shorter term is not without its drawbacks.
According to Rateub.ca, the best rates for three-year mortgages are higher than the best deals available for five-year mortgages. And if rates don’t go down or up, all hope of taking advantage of lower rates at renewal is lost.
Yet Royal Bank mobile mortgage specialist Jimmy Aramouni says clients who consult him tend more towards shorter terms, waiting to see the trajectory of interest rates.
But Aramouni says it’s important for buyers and homeowners renewing their mortgage to also understand their plans for their home in the years to come when deciding on the term.
“Are they going to stay in this property, expand it, sell it, or buy another one?” “, he asks.
“The other key thing is the monthly mortgage payment. How much can they afford to pay each month? Because each term has its own rate. »
Aramouni notes that it is important to consider the term, because if you find yourself in a situation where you have to terminate a mortgage before the end of the term, you end up paying a penalty.
“We recommend that clients sit down with their mortgage specialist, talk to them…and then get their advice. »