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Should I lock in my mortgage rate? Review of Short term or long term Mortgages

Question: I am not sure what I should do with the length of the term of my mortgage? Should I go long or short?

Answer: This is a question asked more than any other. Everyone wants a definitive answer to it. Of course, anyone that claims they can predict future interest rates is somewhat foolish or is making it up. I am neither ... so (as you already know my answer.) it depends. It depends on YOUR outlook for the future:

If you see a generally low inflation environment in the months ahead then you should stay as short of a term as you can, get the 6 month variable rate at 1.5%. You save a great deal on interest and the odds are with you (For if you locked in for five years at say 5.25%, the prime rate would have to rise to over 7.00% from the current 3.75% before you were to pay the same interest as a five year rate. This could be a huge savings to you over the long term.

If you are not sure whether inflation or deflation are coming in the months ahead, then you may wish to play it safe by getting a variable open maximum flexibility ... or analyze the TD product where you pay ¼% over prime but the maximum interest is capped at 6.25% or so for 5 years. Other banks offer some such product as well, such as the BOM which offers a 3.65% variable rate capped at 7.15% for 5 years or the long term/short term mortgage from Scotia bank.

If you believe inflation will be back then you may want to go long go for ten years ... Today’s best 10 year rate at about 6.75% is lower than the US - 15 year rate at 7.09% - and you can get out after 5 years (by law) with only a 3 months penalty. If rates go much higher (in an inflationary environment) or back to previous highs, the long term at this low rate will make your home attractive to future buyers.

You may see a graph showing the spread between short and long term mortgage interest rates and you will see that the wider the gap the greater the savings in going with a short term mortgage!

Whatever you decide to do, compare different lenders and options point by point and research the market in great detail before signing anything.

This is the advice from the Royal Bank website:

Should you go with a short or long-term mortgage?

A longer-term mortgage is worth considering if you have a busy life and don't have time to watch mortgage rates. RBC's 4, 5 and 7-year mortgages let you take advantage of today's rates, while enjoying long-term security knowing the rate you sign up for is a sure thing.

If you want to keep your mortgage flexible right now, you can explore a shorter-term mortgage that usually allows you to take advantage of lower rates and save.

The long and short term mortgage from Scotiabank

This is from SecureApp.com

What Type of Mortgage You Should Get If you are buying a home with less than 25% down payment your choices of mortgage products and terms are somewhat limited...3 year fixed rate or longer under the regular CMHC Program and 5 years fixed rate or longer under the 5% down program.

However, if you are not constrained by the insurance requirements of a high-ratio mortgage there are many options available...they are summarized below. (Note: Not all lenders offer all types of mortgages.)

CATEGORIES and types of mortgages

Fixed-rate 6 month, 1, 2 & 3 year (open, closed and closed-convertible)
4, 5, 7 & 10 year closed.
Variable-rate 3, 4 and 5 year (open, closed, closed-convertible and capped)
Split-term Combination of all possible terms (6 month through 10 years)
Number of portions depends upon lender...3 is most common;
5 is maximum currently available with some financial institutions.
Self-directed RRSP A specialty mortgage - term optional - rate within CMHC guidelines.
Invest your own RRSP funds into all or part of your home mortgage.

Description of the different types of Mortgages and how they apply to you

Short-term risk and Variable If rates are low and stable, and/ or you have decided to take the "staying short" strategy regardless...you can generally pay a significantly lower rate (by up to 2%). This is achieved by simply rolling over your term every 6 months, or having your rate float against prime - with the option of locking in to a longer term at a later date. This is not for everyone, however, as sudden upward rate movements - not unknown in Canada - can cause severe stress.
Long-term Any term 3 years or longer is considered "long term" in today's economy. Because long-term rates are usually higher than short-term rates, many Canadians who have a choice do not select this option. There are many, however, that consider a long term mortgage necessary due to their exposure to rate increases relative to their inability to manage a significantly higher payment.
Split term A mortgage which allows you to minimize - or hedge - your interest rate risk by splitting your mortgage into 3 to 5 parts.
For example: A $150,000 mortgage could be split into five $30,000 segments with terms of 6 months, 1, 2, 3 and 5 year terms negotiated at today's best rates.
The average rate (say, 6.25%) would rise or fall much more slowly than changes in the market, however, as only the shorter terms are affected by even the most volatile rate movements over the first few years.
Protected Variable In 1993 several Canadian Banks introduced the protected variable rate mortgage, which floats at about prime plus 1%, and is capped at (i.e. will never exceed) about 1/2% above the posted 5 year rate. It does offer a way to reduce the risk of floating, while preserving an acceptable long-term rate. (This type is also known as the "capped" variable rate mortgage).
Prepayment Options Annual pre payments - traditionally, 10% to 20% of the original principal balance have been allowed as a lump sum prepayment once a year, often on the "anniversary date". Recently, options of up to 20% of the original balance payable on any payment date have been added to this feature. Finally, the "double-up and skip-a- payment" feature has been included in many offerings. This allows a borrower to "bank" extra mortgage payments for a rainy day, at which time they can just "skip", with the added benefit that, if it never "rains", principal is permanently reduced, along with the interest cost.
Payment changes Most mortgages now allow the amortization to be adjusted by increasing the payment on closed terms by 10% - 20% per year, once annually.
Payment Frequency Most mortgages now come with the option to pay your mortgage at a frequency that matches your cash flow - weekly, bi-weekly or semi-monthly. The added benefit of the "accelerated" weekly and bi-weekly payments is that by dividing a regular monthly payment into two or four respectively, and deducting it at the new interval, an extra payment a year is made directly against principal. The surprising effect of this one extra payment a year is to reduce the amortization of the average mortgage by up to 6 years, with enormous savings of cash at the end of the mortgage term.
With the beautiful Colorado real estate that is available in different neighborhoods like the Castle Rock neighborhoods and the Boulder homes, there is no wonder why Colorado real estate is more popular than ever.

SUMMARY

If you are risk-avoider...go for a fixed rate long-term mortgage, or hedge your bets with a protected Variable Rate Mortgage. If you're a risk-taker, simply stay with a short-term mortgage and watch closely for the signal to lock in a longer term deal. Wherever you can stand the additional cash flow requirement, increase your payment frequency and amount, and prepay principal wherever possible.

My personal experience is this.

I bought my first property in 1984, a townhome at 2145 Sherobee Road in Mississauga and began paying a 25 year mortgage. Back then I had a low risk tolerance for changes in interest rates, so I initially locked in my mortgage for 5 years.

In 1987, I moved to Calgary and broke my mortgage early, paid the 3 month penalty and renewed again at a 'better rate' In 1988 when I decided marketing and sales was the way to go in life and I changed careers, moved back to Mississauga and entered real estate. Again , I locked in for 5 years. Again, I had low risk tolerance and being self-employed I wanted some 'security' in my mortgage payments. In 1992 I locked in again for 3 years.

So far, I had been making a huge mistake with my mortgage rate strategy.

In 1995 I finally 'saw the light' and decided to go short term. I increased my payment frequency to accelerated bi-weekly and reduced the amortization to 15 years. This saved me tens of thousands of dollars over a period of about 7 years.

In hindsight, I should have gone with a short term mortgage from the very beginning in 1984. I performed some approximate calculations, but if I had decided to go with the short term mortgage rates from the very beginning in 1984, my savings in interest payments, charges for IRD (Interest Rate Differential) for my early mortgage renewals to gain a better rate (don't forget, mortgage rates in the mid to late 80's averaged about 12% !) and penalties for 'breaking' my mortgage when we moved, would have been about $45,000! Yes, that's forty five thousand dollars more money that I just 'wasted' and would now have had in my pocket. Another way of saying this is that I could have reduced the term of my mortgage by about 3 years!

If you look at the graph of short versus long term mortgage rates, you will see what I am referring to. Unless the gap between the long and short term rate is very close, it makes total sense to go short term. Even when the gap is little, it will widen again at some point, the banks have to make money. The short term mortgage interest rates would almost have to double before you are breaking even and go up by about 150% for a few years before you were losing money by going short term.

Another 'gem' of advice is this: go with accelerated bi-weekly payments and reduce your initial amortization from 25 years to about 22 or 20 or 18 years right from the very beginning, if you can tolerate the higher payments. The accelerated bi-weekly payments are a must. You will hardly notice any difference and in reality you make a full extra mortgage payment per year. This really adds up over time. Please follow this as much as you can, you will thank me for it in 10 years from now. (Do your own calculations at my mortgage calculator page to see the difference, you'll be amazed at how much you can save!)

Another trick you can try. I know that all of this does not seem like much and it seems so far in the future, but, if you were to buy your first property and initially start with, say, a 21 year amortization for your mortgage (rather than the standard 25 years mortgage that most lenders want you to go with), in five years you have only 16 years remaining. Upon renewal, you pay off a little on the principal and then in another five years you would be down to 11 years remaining. (The math is not that difficult!). By this renewal time your income should have about doubled (compared to your income 10 years ago) and you should be able to comfortably increase your payments substantially and reduce your amortization to say eight years. Thus within 5 years you should be able to save up enough money to pay off the mortgage within another year or so.

Bottom Line: Thus, your '25 year' mortgage just became 17 years, you saved a huge amount of interest and you are now mortgage free! Imagine the freedom.

Even if you follow a plan that is remotely close to our experience, you will be far better off from a financial standpoint. You will have peace of mind and will have the freedom when you are 40 to 45 years old to do some of the things that you always wanted to do in life!

I wish you and your family all the best! Mark

Update on Tuesday, January 16, 2007

I wrote my experiences above a couple of years ago. Today, we have 30, 35 and even 40 year mortgages available. This concerns me a great deal.

If you take out a 40 year mortgage when you are 25, you will not pay off your house until you begin your retirement. You will never be able to save enough to benefit during the important years.

Our philosophy has been to 'live within our means' and by doing so we were able to pay off our mortgage by the time we were in our early 40's This has made our life unbelievably comfortable. We no longer have the pressure of making those huge mortgage payments, just the pressure of saving for retirement. When you are mortgage free, something inside you happens. All of a sudden you have the freedom to purchase those $100 items and not worry about when it appears on your Visa statement. We've continued to watch our cash flow and invest at least half of what our previous mortgage payment was. We don't go on extravagant vacations, but do enjoy our boat. We are lucky as we also enjoy our own company and times together as a family.

This is our experience. My wife and I truly believe that your 40's and 50's is the time to enjoy life, as your children are getting into their early teens and can take more care of themselves. This is the time to enjoy life, while we have the energy to do the things that we want. As I approach 50, and anyone at my age or older will attest, your body just doesn't move at the same speed as it did when you are 35 and the recovery period is longer. This is a fact of life and aging. I can't even imagine what it will be like at 60, but I'm not waiting until 60 to enjoy life. All of this is possible by taking care of business during your 30's.

Now, some will say that home ownership is better than renting, whether you have a mortgage or not. Some will also say that if you didn't buy the house at 30 you would not have anything when you are 65. This is true too. I completely agree with home ownership, but at the same time, I think we have to manage our debt better in our 30's to enjoy life in our 40's. I think that your early twenties are the fun times, late 20's are your working years, your 30's are your hardest years with children and debt, your early 40's are your prime working years and the time to pay down debt at the highest rate possible, your late 40's to late 50's are your prime earning years and prime enjoyment years, so enjoy them, your 60's are your slowing down and 'chilling' years with your grandchildren, you won't need the huge income you earned during your 40's and 50's but, you will be glad you saved during those years. Your 70's are for looking back on the rest of your life and anything over 80 is a bonus. Personally, my goal is to absolutely, unequivocally and without a doubt, live to be 100 or a little older than that. I want to enjoy the next 50+ years of the internet and high-tech age.

Another disturbing trend that seems to be rearing it's ugly head is reverse mortgages. I had a great conversation with a mortgage friend/ financial planner last week and his comments were that people are generally retaining debt and refinancing their homes throughout their lives up to their 50's and early 60's and then when it comes time to retire, they are taking reverse mortgages to pay for their retirement. Oh my, what a horrible way to go through life. I can picture it now, buy your house at 28 years old and get a 35 year mortgage and then when you have paid it off, take out a 20 year reverse mortgage for 75% of the value to fund your retirement. Some may say that this is a perfectly fine method of life planning, but I can't agree with that. Not only will you carry debt for your entire life, but you will have almost nothing to leave to your children. Again, these are my values, but our children really are our legacy.

So, for those of you that are just starting out in your 20's or even if you are in your 30's I do hope that you can get hold of your financial situation, pay down some debt, get rid of credit card debt, get that mortgage paid off by the time you are in your mid to late 40's and enjoy your life with your kids before they leave you!

I wish you all the best,

Mark

Remember ...because mortgage interest is not tax-deductible, every dollar you pay off your mortgage gives you an AFTER TAX RETURN of whatever your rate is, because you're saving interest you'd otherwise have to pay with after-tax dollars!

I've decided that I will begin to dedicate this webpage to some of my past and current clients that I have connected with or that I feel could really benefit from this 'unsolicited' advice above. They know who they are and some of them I want to give an honorable mention to keep them motivated:

Iain and Leaha (I wish all my clients were like you two were and wish you many years of success and happiness)

Sonja and Mark (I wish all of my clients were as excited about buying a home as you were! You were a real pleasure to work with)

John and Roodya (I wish all my clients gave me hugs and encouragement like you two did!)

Fabio and Kelly (I wish you all the best of success and happiness and I hope you stick to your plan)

Scot and Julia (One of the most enjoyable and fun sale of a house and purchase of a house)

Marna and Isabel (I hope that this page inspires you to follow your own plan and enjoy your upcoming new life and baby! wish we could have spent more time together)

Norm and Sue (You have everything under control and I never learned so much as I did from the two of you)

Mike and Laurie, Steve and Linda, Silvyn, Joerg and Kathrin, Colin and Sharon, Gary M. (what a class guy), Dave and Lorna, Jim and Marcy, Tar and Suneeta, Deb S. just some of my past clients that I reflect upon with such happiness and satisfaction - none of you really know how much I appreciate your business and how happy I am that you were able to sell for top dollar and buy such a great home

I've reached a point in my career (nearly 20 years) where I can look back at the 100's of families that I have helped and say that it really is truly satisfying to have helped all of you reach your goals, dreams and aspirations. I am blessed to have been able to work with such nice people as you.

I wish you all much success, good health and happiness always,

Mark

You may see a graph showing the spread between short and long term rates and you will see that the wider the gap the greater the savings in going with a short term mortgage!

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Mississauga MLS Real Estate Properties & MLS.CA Homes for Sale All Pages including SiteMap, Add URL , Mississauga Real Estate Blog and Guestbook maintained by A. Mark Argentino, mark@mississauga4sale.com Copyright © A. Mark Argentino, P.Eng., Broker, RE/MAX Realty Specialists Inc., Brokerage, Mississauga, Ontario, Canada L5M 7A1 (905) 828-3434 First created - Tuesday, July 16th, 1996 at 3:48:41 PM -
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