There are not a lot of times when 10 year term mortgages are in the discussion, but in today’s low rate environment, this is one of those times. Here are 2 scenerio’s which might help in your decision making. In today’s market a 5 year fixed mortgage is priced at 2.99% (at some lenders) whereas a 10 year is priced at 3.89%. We know at some point in time the rates are invevitably going to rise….most likely in the next 5 years. So what if you decided to take a 5 year mortgage at 2.99% and rates increased by the end of your term and you were subject to a renewal rate of 5.50% for another 5 years….how much of a difference would it have made if you decided to take a 10 year term at 3.89% and secured that rate for 10 years? Let’s look at the numbers:
*The following scenarios are based on a mortgage amount of $250,000 and an amortization of 30 years.
Option 1 – 5 year Term at 2.99% (year 1 – 5) and renewal rate of 5.50% (year 5 – 10)
- Payment $1,050 per month for years 1 – 5 and $1,253 per month for years 5 – 10
-Outstanding balance at end of year 5 – $222,150 and at the end of year 10 – $205,232
-Payment shock/increase at the end of year 5 = $203.00 (your payments will increase by this amount when your rate goes from 2.99% to 5.50%)
*Decrease your payment shock: Inflation Hedge Strategy -
Option 2 – 10 Year Term at 3.89%
- Payment $1,173 per month for 10 years
-Outstanding balance at end of year 5 – $225,599 and at the end of year 10 – $196,015
-Payment shock/increase at the end of year 5 = $0
If you took the 5 Year and renewed at a rate of 5.50%, your outstanding balance at the end of 10 years would be $205,232, and if you took the 10 Year your outstanding balance at the end of your term would be $196,015. When comparing the two scenarios the 10 year would put you ahead after the 10 years by $9,217. Significant…yes!
The other important factor to look at is, what if 5 years from now, interest rates have not gone up significantly and were only say 3.50%, then one could argue that a 5 year term would have been better. Keep in mind, that all lenders can only charge 3 months interest and no IRD (interest rate differential), after 5 years on terms longer than 5 years. So if that happended, then just after the 5 year mark you could pay a 3 month interest penalty and refinance to the lower rate. You would still be ahead in the long run.
With this strategy, you have more flexibility with your mortgage, the security of a 10 year term and the potential to save in the long run. So for a 5 year term to be better, rates are going to have to stay very low over the next 5 years which, nobody can predict, but it does not seem likely, so why take the risk.
As always we are here to help. We can work out your numbers and see if the above strategy makes sense for you!
CAAMP (Canadian Association of Accredited Mortgage Professionals)
GENWORTH FINANCIAL CANADA
MBABC (Mortgage Brokers Association of BC)
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