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How to select the right mortgage term in today's changing market

Nov. 11, 2022
4 mins
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Choosing a mortgage term can be difficult, but after six Bank of Canada interest rate hikes this year, it’s become more confusing for many Canadians.

When interest rates hit record lows during the peak of the pandemic, many buyers dove into the real estate market. Since then, however, the overnight interest rate has shot up from 0.25% to 3.75%, making it more expensive to take out a mortgage. The market will likely continue to change as we move into the end of the year, so picking the right mortgage term is more important than ever.

Your mortgage term is the length of time you are locked into a mortgage with a specific lender at its rate and conditions. Whether you go with a long- or short-term mortgage, you should discuss your options with a qualified real estate agent in your city. It’s also important to compare mortgage rates and terms that you would qualify for before you commit. Both term lengths have pros and cons, so here’s what you need to consider before locking into either.

Short-term mortgages: what to consider

Short-term mortgages generally last three years or less. If rates are likely to stay flat or decrease in the next few years, then a short-term mortgage can be ideal. This way, at renewal you can lock in a similar or lower interest rate, further decreasing your monthly payments or increasing the amount you pay toward your principal.

Keep in mind, though, that interest rates on short-term mortgages are higher because the lender isn’t able to collect interest from you for as long. And, since interest rates have risen, it’s becoming increasingly difficult for some buyers to qualify for shorter mortgage terms.

As the stress test becomes harder to qualify for, many lenders prefer that clients consider a long-term rate to protect themselves in case interest rates continue to rise and are higher at renewal. If you’re confident in the state of the market or will be able to take on higher payments at the time of renewal, then a short-term loan might be right for you.

Long-term mortgages: what to consider

Long-term mortgages are generally considered to be anything five years or longer, which historically has been the most popular term length among Canadians.

A long-term mortgage is ideal if you’re planning to stay in your home for at least as long as your mortgage term. You’re likely to pay less interest with a longer mortgage term, as five-year rates are often lower than two- or three-year rates. If you were able to secure a long-term mortgage at a lower fixed interest rate, and rates are expected to continue increasing in the future, then this term length can pay off.

The one thing to keep in mind with a longer term, however, is that if interest rates drop in the next year or two and you’re locked into a higher rate for five years, you can’t break your mortgage without paying a penalty.

Which type of mortgage rate is best — fixed or variable?

When selecting your term, you’ll also need to consider whether you want a fixed or variable interest rate.

A fixed rate stays the same for the entirety of your term, which can be handy if you value consistency and budgeting over the risk of a fluctuating rate. However, fixed rates tend to be higher than variable rates, which can lead to less purchasing power. The higher the rate, the lower the amount of mortgage you may qualify for to borrow.

A variable rate will change with the Bank’s prime lending rate. This is a good option if interest rates are low or are expected to drop, and tends to provide a little more flexibility so you can manage changes month by month. While rates may continue to increase in the short term, you will need to budget appropriately, but you will likely pay less in the long run.

If your situation changes or interest rates take a large dip, you can talk to your lender about breaking your mortgage and switching from a fixed to variable, or vice versa. There are penalties associated with this — and they’re different for fixed versus variable mortgages — but it’s worth remembering that you are ultimately committing to the home, not the rate or term.

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Compare Mortgage Rates

Engaging a mortgage broker before renewing can help you make a better decision. Mortgage brokers are an excellent source of information for deals specific to your area, contract terms, and their services require no out-of-pocket fees if you are well qualified.

Here at RATESDOTCA, we compare rates from the best Canadian mortgage brokers, major banks and dozens of smaller competitors.

Patti Cosgarea

Patti is the public relations and content marketing manager at Zoocasa, an award-winning brokerage that uses data and technology to deliver an intelligent, end-to-end real estate experience in Canada.

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