Why I Chose A Five Year Term For My Mortgage

by Mike Holman

Last year I felt a lot of stress from being financially over-extended in the form of a mortgage that was too large. One of the obvious remedies to this problem was to concentrate on lowering that debt, which we’ve done with some success. The other significant thing we did was to lock in our mortgage for five years. I realize that studies like the one done by Moshe Milevsky show that shorter terms are cheaper in the long run for mortgages, but in our current situation, the peace of mind of not having to worry about the possibility of increased interest rates is well worth any extra cost that locking for five years might end up causing.

The reason the mortgage payment is such a concern is because our budget is too tight to handle a big increase in payments if interest rates jump up. By locking in, we don’t have to worry about that for five years, at which time the mortgage will be low enough, we’ll be able to handle higher interest rates if need be.

I can’t predict if interest rates are going to go up or down in the future, but I can accurately predict that with the longer term mortgage, I will sleep better at night.

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{ 18 comments… read them below or add one }

1 The FinancialBlogger

Hi Mike,
I can understand why people are signing for 5 years mortgage for the past 5 years actually. Even now, 5 years terms are pretty interesting. That saves a lot of cash flow problem for a while.
However, have you considered a home equity line of credit? This product permits to change your payment amount anytime and give you the opportunity to pay prime on your mortgage.
Cheers,
FB.

2 FourPillars

FB – I haven’t really considered a HELOC for the mortgage itself because prime is 6% and all the fixed rates (even the one year term) are well below that figure.

The fixed mortgage also gives you lots of flexibility to make extra payments so there is no concern there.

3 Telly

With a tight budget, I don’t blame you for choosing the 5 year term. We already know that rates are going up in July but who really knows what will happen after that. Sleeping better at night is worth at least 1/2%. :)

We currently have 2 years left on our 5 year term. It turns out that going long was actually a benefit to us as we’re at 4.39% but we didn’t really know what to expect. We just did what everyone else was doing!

4 Riscario Insider

Piece of mind is very important.

In the spring of 1994, we took a 10 year mortgage at roughly 8% (which was probably 1-2% higher than the 5 year rates at the time).

Our previous mortgage had been 6 months open with rates starting at 13.5% in 1991 and dropping to 6% in 1994. I’m glad we didn’t lock in at the initial rate :)

5 FourPillars

That’s interesting Riscario – 8% sounds very high now but obviously at the time it must have seemed like a great deal.

6 Mr. Cheap

I always think that with the ability to pre-payment there are ways to mitigate the fixed-rate mortgage if rates drop. If they drop enough, just increase your payments to max and move the maximum possible each year to a HELOC or a second mortgage. Sure you won’t get as good a rate as a 1st place variable, but it gives you a way to take advantage of rates dropping significantly (and if they don’t drop significantly, who cares about the small “lost savings”?).

7 FourPillars

Mr. C – that’s a great strategy if rates fall low enough.

Now that I think about it, I could have done that with my first mortgage a few years ago when rates dropped.

Mike

8 Canadian Mortgage

Hi Mike,

Great points. There’s absolutely nothing wrong with paying a potential premium for comfort. That’s why people buy insurance.

As of today, the typical discounted 5-year fixed is roughly 5.79%. It would take three one-quarter point rate hikes to bring today’s variable rate mortgages on par with that. So it becomes a calculated risk for some people.

With a $300,000 variable rate mortgage, your payment could pop $130 a month with a 3/4 point rate hike (assuming your mortgage doesn’t have a hold the payment feature).

If cash flow is tight, and that scares you, you’re best to go fixed.

All the best,
– Melanie

9 FourPillars

Thanks Melanie. Another thing I learned is to get the mortgage renewal process underway as soon as possible. Had I waited until now to look for a new mortgage, I’d be looking at 5.79 instead of 5.19.

Mike

10 Canadian Mortgage

That’s for sure! When the bond market is selling off and herd mentality takes over, lenders start raising rates quickly.

11 Livingalmostlarge

American married to a Canadian, how do you address all the PF bloggers who are americans preaching the 30 yr fixed mortgage?

I almost came to blows with my MIL over why a 30 year fixed is the best, but she was HORRIFIED! At most 5 years, we have a 7/1 Arm for reasons discussed on the blog, but I want other more “normal” canadians to write about their mortgages. Oh and I would have gotten a 30 year fixed if it were our final home, but it’s not. And it was the lowest ever rates for 30 year fixed.

That way some stupid americans would understand that Arms are not evil or bad, but in some countries more typical. Because you have a lot of bloggers who talk about the downfalls of credit, etc. What’s the canadian perspective on Arms?

12 FourPillars

LAL – I don’t think we have adjustable rate mortgages as far as I know.

My perspective is that they can be useful financial tools for people who understand how they work but unfortunately they have been marketed to inappropriate clients who ended up buying more house than they could afford.

Mike

13 Canadian Mortgage

ARMs are more commonly called VRMs (variable rate mortgages) in Canada. The two terms are mostly synonymous but technically you could argue a few distinctions:

* It’s more typical (or at least it was) in the U.S. to have teaser rates (like 2/28 loans) attached to an ARM
* In the U.S. borrowers were often qualified on the lower of the teaser or post-teaser rate (not a good idea obviously)
* In Canada, when interest rates rise, payments generally don’t. That’s not true in the U.S.

Have a wonderful evening!
Melanie

14 jomo

i was wondering if anyone can answer my question for me what whould be the best choice for an average person to take a fixed mortgage or a variable one

15 Mr. Cheap

jomo: There’s no one answer to that question. Banks and mortgage brokers like to say that over the long term, on AVERAGE its been cheaper to get a variable mortgage.

The obvious benefit to a fixed mortgage is you know exactly what your payments will be over the period of the loan (no surprises when interest rate suddenly change).

You have to decide which is right for you.

16 jomo

thanks alot on the reply i allready got everything ready on a 5 year variable mortgage at 4.1% but me and my fiance are on fixed budgets and in the last two weeks its jumped to 4.75% variable rate and my fix rate i was getting 5.20% went up to 5.35% plus all the stuff dats happening in the states and stuff is kind of scaring me so i thought let me get someone eleses view on it cus the bank is gonna tell u what u wanna hear cus its there best intrest to make ass much money ass they can and ive bin reading alot on the net 7/10 ppl choose to take a fixed mortgage than taking a fixed one

17 jomo

mr cheap i was wondering is a fixed rate of 5.35% seem ok

18 Mr. Cheap

jumo: PC Financial (who I got my mortgage through) is offering a fixed rate of 5.79% on 5 year, so 5.35 sounds pretty good to me. You can get a 4.6% variable from them too. Or call a mortgage broker (Melanie and Rob at http://www.canadianmortgagetrends.com are nice if you’re in Canada) and see if they can beat what you’re being offered.

You can get pre-approval to “lock in” rates for up to 4 months, which is great for exactly the situation you found (so they don’t jump up on you right before you close). If rates go down they’ll give you the lower rate…

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