A Wise Move in Uncertain Times : The Advantage of Navigating Various Rate Options

One of my main responsibilities as a Mortgage Agent is to help my clients navigate the murky waters of interest rates and ensure they are finding a suitable solution for their goals. Recently many people have been considering taking shorter fixed terms (2 to 3 years) in hopes that rates decrease in the coming years. Choosing the right mortgage rate can be a significant decision for homeowners. It requires careful consideration of the prevailing market conditions, interest rate trends, and personal financial goals. In an environment where rates may decrease in the near future, opting for a slightly lower 5 year fixed rate mortgage or higher 5 year variable rate can provide several benefits over a 2 or 3 year rate. This article aims to highlight these advantages, shed light on the interest rate needed to break even, and explain why a 5 year term mortgage is advantageous in uncertain times.?

Let’s start with the benefits of a 5 year fixed rate option:

Stability and Peace of Mind: One of the primary advantages of opting for a 5 year fixed rate mortgage is the stability it provides. By securing a fixed interest rate for a more extended period, homeowners can effectively plan their finances with confidence. This stability offers peace of mind, shielding you from potential interest rate fluctuations that could impact your monthly mortgage payments.

Long-Term Savings: While it may seem counterintuitive to choose a slightly lower interest rate for a longer term when rates are expected to decrease, the long-term savings associated with a 5 year fixed rate mortgage can be substantial. By locking into a lower rate for five years, you are effectively insulating yourself from potential rate hikes in the future. Even if rates drop in the next three years, the slightly higher 3-year rate would need to decrease significantly to just break even. See example below.

Interest Rate Needed to Break Even: To better understand the interest rate required to break even between a 5-year fixed rate and a higher 3 year rate, let's consider a hypothetical scenario. Suppose you are considering a $300,000 mortgage at a 5-year fixed rate of 3.5% versus a 3-year fixed rate of 4%. Over the course of the 3-year term, you would pay approximately $34,500 in interest. Now, let's assume rates decrease after three years to 3%, which is a significant drop. To break even and save the same amount in interest, the 3-year rate would need to drop below 2.25%. Achieving such a significant decrease is unpredictable, unlikely and not guaranteed.

Now let’s take a look at the 5 year variable rate option. While a higher 5-year variable rate mortgage may seem counterintuitive compared to a fixed rate, it offers distinct advantages in terms of flexibility and conversion options.?

Lower Penalties for Early Termination: One of the key advantages of a 5-year variable rate mortgage is the reduced penalties associated with early termination. Life circumstances can change unexpectedly, and homeowners may find themselves needing to sell their property or refinance their mortgage before the end of the term. The average mortgage in Canada is broken within 36 months of funding. In such cases, variable rate mortgages come with lower penalties compared to fixed-rate mortgages. This flexibility can be especially valuable in situations where you anticipate changes in your financial situation or if you plan to move or upgrade your property within the next few years.

Conversion Options: A higher 5-year variable rate mortgage also provides the option to convert to a fixed rate mortgage if interest rates decrease in the future. This feature allows homeowners to take advantage of potential rate drops without incurring any penalties or refinancing costs. By converting to a fixed rate mortgage, you can enjoy the stability and predictability of a fixed interest rate for the remainder of your term.

Potential Interest Savings: While a higher variable rate may seem less appealing initially, it's important to consider the potential interest savings associated with this option. Variable rates tend to be lower than fixed rates historically, which means you could benefit from lower monthly mortgage payments in the later years of your mortgage term. This extra cash flow can be used to invest in other areas, pay down debts, or contribute to savings.?

There is no black and white answer to this question as everyone’s financial picture and goals look different. Rates are impacted by a multitude of different factors that we as consumers have little to no control over. Meaning it is important to fully express your goals and financial picture to your Mortgage Agent when acquiring your mortgage. As always, I am available to discuss your personal financial goals and situation. I would encourage you to reach out via my website at www.paulstevenson.ca.?

Have a fun and safe Canada Day with your loved ones!?

- Paul S