Mortgage vs. HELOC
With so much focus on mortgage rates, consumers often neglect one of the most important decisions in mortgage financing, choosing the mortgage term. It is not always about choosing the lowest rate but more so about choosing the mortgage product with the conditions and mortgage term that best fits your needs. Choose a mortgage term that’s too long and you could be bound by an unnecessarily high rate or be surprised with excessive penalty fees if you need to break the mortgage early. Choose a mortgage term that’s too short and you could be exposed to great interest rate risk at renewal that may put a big strain on your budget.
A mortgage term is the length of time over which the borrower is agreeing to abide by the conditions of the mortgage. Over this period the legal parameters of the mortgage are in effect – interest rate, pre-payment restrictions, etc. At the end of the term, the borrower can pay off the remaining balance of the mortgage, renew it, refinance it or switch lenders.
A mortgage term can generally range from 6 months to 10 years, with 5 years being the most common term length. Mortgages with terms fewer than 3 years are considered short term mortgage while mortgage with a term of 3 years or more is classified as long term mortgage. A mortgage term is different that the mortgage amortization, the period of time over which the mortgage balance will be fully paid off. A mortgage term is normally less than the mortgage amortization, unless the borrower is close to paying off the mortgage.
According to the Canadian Association of Accredited Mortgage Professionals report from November 2010, 26% of borrowers have a term of less than 5 years, 66% have a term of 5 years and 8% have a term greater than 5 years. The report also shows a higher tendency for younger borrowers to choose shorter terms (26% of 18-34 years of age chose a term less than 5 years) relative to older borrowers (18% 55+ years of age chose a term less than 5 years).
Short term mortgages carry better rates than long term mortgages. However, borrowers are more exposed to interest rate risk with a short term mortgage given that it needs to be renewed more frequently. For example, consider two people - one purchases a 10-year mortgage and the other purchases a 2 year mortgage. If rates increase during the first 2 years the person who purchased a 2-year mortgage will be affected by having to renew at a higher rate. The person who purchased a 10-year mortgage will still be paying the rate in their original mortgage agreement.
If you believe rates will stay flat or decrease in the future, a short term mortgage could be a good fit. A short term mortgage would also be appropriate in the following circumstances:
Long term mortgage generally carry higher rates than short term mortgages, but also provide greater protection against the risk of rising interest rates. It is important to make sure that you don’t purchase a long term mortgage unless you’re sure that you won’t need to sell your home or refinance your mortgage prior to maturity. Penalties for breaking your mortgage early can be a lot more significant on a long term mortgage.
If you believe that rates will increase in the future, a long term mortgage could be a good fit. A long term mortgage would also be appropriate in the following circumstances: