Timing is Everything

Is a five-year fixed mortgage term really for you?

By Kris Grasty, mortgage broker with Dominion Lending Centres Canadian Mortgage Experts
Often when I meet clients, the first question that I hear is “What is your best five-year fixed rate?”
My typical response is to inform the client that rate is not the only factor to consider and I ask them why they would like to get into a 5 year term. Most of the time, the client’s do not even know why and some are unaware that other terms exist. There is a discussion to be had on “it’s not just about rates” that I will follow up with in another post. To be clear, I am not intending to argue that a 5 year term is bad, simply that it may not be the best fit for everyone at all times.
Industry statistics show that up to 60% of 5 year fixed term mortgages are broken at the 38 month mark. When I first heard this, I didn’t believe it so I applied the stat to my own experience. I have had 3 mortgages prior to becoming a Mortgage Broker and all without being really informed by a licensed Mortgage Expert. So just for fun, here is how it played out for me; 
1st 5yr broken at 2 years 
2nd 5yr renewed early at 4.5 years 
3rd 5yr broken at 3 years 
So, 3 Mortgages in 9.5 years or 38 months! I was blown away, but alas, I am a statistic!
On the first occasion, we were selling and upgrading to a larger family home, the second time we renewed with our current lender a little early. The third time was due to a career change. In the end, these life changes cost us approximately $10,500 in interest penalties, one of the reasons I became a Broker.
“The overall reason for my mortgage movement and those of most Canadians – life happens! Every one of us is susceptible to life changes that require us to reassess our financial situation, such as; marriage, having children, upgrading to a larger home, illness in the family, relocation and employment changes, just to name a few examples.”
There is another aspect to consider. You get nice and cozy with your locked-in rate for 5 years, but what happens if rates normalize near 5.00% by 2018? Mortgage shock that costs you money and impacts your quality of life OR panic can set in that entices you to change up mid-stream. Let’s look at an example to explain a bit further. ***Future rates are purely speculation and for illustration purposes only***
 


Scenario 1; You lock in for 5 year term on 25 year amortization, stay the course and renew with another 5 years.
$300,000 Mortgage
5yr | 2.99% | $1418.20/month | Balance $256,374
5yr | 5.50% | $1754.61/month
Mortgage Shock – increase of $336.41/month
TOTAL PAID (6 yrs): $106,147
TOTAL INTEREST PAID (6yrs): $55,228
Scenario 2; as rates increase after your 3rd year, something happens in your life and you need or want to switch to a shorter term product at a lower rate than the rising 5 year rates. Ex. a 3 year fixed at 4.00%.
5yr | 2.99% | $1418.20/month | (Balance end of year 3 is $274,604)
$274,604 Mortgage
Interest Penalty approx. $6000.00
3yr | 4.00% | $1560.89/month | Mortgage Shock – reduced to $142.69/month
By the end of year 6, just to keep the comparison, the balance is +/- $249,680.
TOTAL PAID: $113,247 (penalty incl)
TOTAL INTEREST PAID: $56,928
Scenario 3; You originally choose a shorter 3 year term, 25 year amortization, and renew at end of year 3 without penalty at the same rate as above.
$300,000 Mortgage
3yr | 2.65% | $1366.42/month | Balance $273,524
3yr | 4.00% | $1554.75/month | Balance $248,698
TOTAL PAID: $105,162 ($4085 less Paid)
TOTAL INTEREST PAID: $53,861.23 ($3067.58 less Interest)
“A Variable mortgage typically only exposes you to a 3 month interest penalty and though there is a risk of rate movement, the Variable option has been historically proven to win over all.”

Clearly, option #3 works out better in this scenario for 2 reasons. First, the option to renew or switch earlier is without penalty and provides an opportunity to re-assess your situation. The second, is that taking advantage of the lower rate reduces overall monthly payments for a combined savings of $4085 CASH in YOUR pocket! You have just won for 6 years instead of just 5.
Not brought into the argument is Variable vs. Fixed which is an entirely different discussion. An earlier renewal may just tie in nicely with a return of better discounted Variable rates as Fixed rates move northward.
A Variable mortgage typically only exposes you to a 3 month interest penalty and though there is a risk of rate movement, the Variable option has been historically proven to win over all.
So with shorter terms, variable terms and penalty exposure risk in mind; I leave you with my question; is a 5 year fixed really for you?
Original source: Metro Vancouver New Condo Guide – October 17 – 31, 2014 issue