A 5-year fixed rate refers to a mortgage that has an interest rate that is locked in for five years. The rate and payments cannot increase or decrease until the mortgage comes up for renewal unless you refinance.
Most 5-year fixed rates are closed, meaning you cannot get out of the mortgage contract early unless you pay a prepayment charge (a.k.a. “penalty”).
The 5-year fixed term has long been Canada’s favourite.
A whopping 74% of all Canadian mortgages were fixed rates according to a 2020 report by Mortgage Professionals Canada. The majority of those being 5-year terms.
It’s a popular term because it strikes a balance between a competitive mortgage rate and a term length that gives borrowers confidence. Let’s face it, even though shorter two and three-year terms often offer lower rates, many borrowers don’t want to deal with the perceived hassle of renewing their mortgage so often. (In reality, one only needs to dedicate about 4-5 hours to close a new mortgage, but that’s another story).
Some consider the 5-year fixed to be the Goldilocks of mortgage terms. It’s not too short and it’s not too long, unlike a 7- or 10-year fixed. Although, one could argue that 3- and 4-year fixed terms are more ideal given they better match the 3.8-year duration of the average mortgage.
In any case, a 5-year term provides borrowers who are concerned about rising rates with the comfort of knowing their mortgage payments aren’t going to change for half a decade. Not to mention, any terms longer than five years entail healthy rate premiums and more onerous prepayment penalties.
Interestingly, among those renewing a mortgage in 2019 and switching terms, a full 37% of all renewals moved into a 5-year fixed, according to Bank of Canada data. People tend to be less likely to renew into long-term fixed rates as they get more financially secure. Paying a big 5-year fixed prepayment charge is another consideration that sours people from the term.
Fixed rates in general owe part of their growth in popularity to multi-year lows in bond yields. Falling bond yields lead fixed mortgage rates lower given that so much fixed-rate mortgage funding is geared to bond-like instruments.
|Year||Avg. 5-yr Fixed Rates|
The best 5-year fixed rate depends on your five-year plan and personal situation. You always want to achieve the lowest overall borrowing cost. Not necessarily the lowest rate.
Factors to consider when evaluating any 5-year fixed rate include:
When shopping for a mortgage, it’s crucial to compare terms, not just rates. That way you ensure you’re getting not only the best value possible but a mortgage product that gives you the flexibility you require. Lack of flexibility can cost you.
There are always many things to consider before settling on a term. Despite a majority of Canadians gravitating to 5-year fixed mortgages, it’s possible that may not be the best mortgage for your situation.
Like any mortgage product, there are pros and cons of the 5-year fixed. Here are some of them:
Over the long run, competitive 5-year fixed mortgages are priced about 1.50 percentage points above the 5-year bond yield. Hence, 5-year fixed rates more or less follow the movements of the 5-year Canadian bond yield, except when the financial system is stressed, as it was in 2020 and 2008.
As bond yields rise and fall based on investors’ inflation expectations and other factors, so too do fixed mortgage rates.
This correlation is due to mortgage lenders relying on the fixed-income market for mortgage funding. Market forces determine the interest rate they must pay on the money they are lending out to you at a higher rate. This difference between what they are paying and what they are earning is referred to as a “spread.”
A perfect example of the fixed/bond link was the historic fall in bond yields in early 2020. That drop coincided with mounting fears over the coronavirus and plunging oil prices, which led directly to steep discounting of fixed mortgage rates. That is, until fears of credit defaults spiked risk premiums and mortgage rates shot back up temporarily.
|Year||5-yr benchmark bond yields||Avg. 5-yr fixed rates|
Five-year fixed rates have been falling for almost 40 years thanks to Canada getting inflation under control and a slowing economy. Looking back over past decades shows what fixed rates were capable of, but we will likely never again see double-digit 5-year fixed rates. The economy simply couldn’t support (or justify) those kinds of interest costs.
Discounted fixed rates—which are more indicative of the actual rates paid by borrowers compared to posted fixed rates—reached just shy of 6% as recently as January 2008. But consumer leverage is much higher today, so the economy is less able to withstand such rates.
Following the credit crisis of 2008, 5-year fixed rates subsequently trended lower for over decade. The all-time low was 1.91% in November 2016. After a brief spurt following the Trump election win and economic growth, rates dove in 2019which brings us to the current point in time.
|Year||Avg. of lowest nationally available insured and uninsured rates|
Where are 5-year fixed mortgage rates going in 2020? As noted above, fixed rates are largely dependent on moves in the Canadian bond market.
With bond yields collapsing with record speed in March 2020, expectations are for fixed rates to continue to fall by year-end, once default risk from the coronavirus is fully understood.
Fixed rates are expected to remain relatively low coming out of the 2020 recession for the next 2-3 years, minimum.
Banks use all kinds of sources to fund 5-year fixed mortgages, including:
A blended cost of funds is often derived from the above sources and that forms the basis of 5-year fixed mortgage pricing. On top of that, lenders try to earn enough to pay staff, sales and marketing expenses, overhead and a small profit (which often amounts to less than ½ per cent of the mortgage principal, plus renewal and servicing revenue).
If a lender ever tries to offer you its posted 5-year fixed rate, make a beeline to the door. That is, if its posted rate does not equal its lowest rate.
Canada’s typical 5-year posted rate is currently 5.04% (as of March 2020). If that seems high, it’s because it is. As of this writing, it’s more than two percentage points above the average 5-year fixed rate.
No well-qualified borrower should ever accept a mortgage rate based on the average 5-year posted rate. Major banks maintain high posted rates for specific reasons. The main one being those mortgage breakage penalties we mentioned earlier. Prepayment penalties are based on posted fixed rates. So, it’s in big banks’ best interest to keep those rates artificially high.
The typical 5-year posted rate from Canada’s big banks has also been used in determining the minimum qualifying rate for the mortgage stress test. The government announced plans to change that in early 2020, but it was temporarily derailed by the coronavirus crisis.
|Year||5-year Posted Rates|
Quick statistical facts on Canada’s favourite mortgage: