No single mortgage out there provides the best value for all home-buyers. Most of them have their merits for existing on the market; by targeting specific income bands, couples, first-time buyers. You get the gist.
Moreover, with all these “unique,” “super saving” deals as well as cash-back incentives, it can be complicated to figure out which one is going to suit your needs. Five-year fixed rate mortgages are the most common option amongst Canadians, and with the increase in interest rates, many of them are happy with their decision.
What is the current mortgage situation?
Mortgages are dependent on what investors in the market want, and at the moment five-year fixed rates are what lenders are finding most saleable to investors. What this means for those of you in the market for a mortgage are more competitive rates and offers. However, if we zoom out and have a look at the mortgage market in Canada overall, we can see interest rates steadily increasing.
Bank of Canada interest rates are set to rise this year and that is already after two hikes in 2017. This combined with the more stringent rules and stress tests implemented at the start of this year means that it is not an easy time to get on the property ladder.
The property market is responding to the financial strain on borrowers and we can see house prices dropping; though not in complete tandem with interest rates.
Where do I start?
It is essential to map out the type of mortgage you need before you even start looking at what banks and other lending providers have to offer. This way you can narrow your focus and not be distracted by offers that are irrelevant to you.
As the title states, we’re kicking this off with a look at five-year fixed rate mortgages. However, we’ll also be looking at the pros and cons of the mortgage types available on the Canadian market in a series of articles this month.
What exactly is a five-year fixed rate mortgage?
The five-year denotes the mortgage period, not to be confused with the amortization period. The mortgage period is the length of time you agree to stay with a specific mortgage holder. You are probably familiar with the term being referred to as a “lock-in period”. This has nothing to do with the length of time you set aside to pay back your mortgage which is the amortization period.
All mortgages fall under two umbrella categories: fixed rate and adjustable rate mortgages. We’ll discuss ARM in a later article but for now here’s what you need to know about interest rates for this article’s purpose. If you choose this option your interest rate remains solidified for five years. After this period your mortgage will be transferred to a standard mortgage account which essentially means your interest rate will be determined by the lending market. So, why exactly would a fixed rate be suitable for you?
Best of both worlds
This product is an enticing blend of stability and competitive interest rates. You are not locking yourself in for a decade but still allowing enough time to have loan security. Going any longer than five years and interest rates no longer provide value for money. You will end up paying much more in the long run.
What’s more, if you decide to save a repayment sum you’ll be hit with a penalty for paying back early. It’s hard to predict what will happen in a decade, what with promotions, job offers and career changes that might come your way. It is, undoubtedly, a much more manageable process to plan repayments based on the next five years, which brings me nicely onto my next point.
Easier to Budget
Although there are some out there that thrive on the chance of saving by taking a risk many of us are not so keen to have a fluctuating mortgage payment. For five years you’re looking at a fixed interest rate which removes the stress of having to find money if interest rates catapult. You won’t be worrying about the what-ifs and can confidently budget for your house repayments. Also, if your stress tests allow this means you can apply for larger monthly payments if you wish because you won’t have to set aside money for increased rates. The obvious downside of this being that if mortgage prices drop you’ll be stuck at your pre-agreed rate.
Unlike an interest-only loan, a proportion of repayments to a five-year fixed rate mortgage go towards the principal; that is the initial cost of the house. Although it isn’t as effective as an ARM, it does increase your home equity.
Interest-only loans have become much less attractive in Canada in the last ten years. Even though the monthly repayments are lower, there are many risks involved in deciding to only pay off the interest on your property. I’ve seen people take out mortgages for houses that should really be outside their budget. Unless you’re savvy and have got a game plan to pay off the principal I’d recommend increasing your home equity consistently through a fixed-rate option.
Why this mortgage isn’t for you…
- You’re looking for the cheapest interest rate
As I’ve highlighted this particular product is not the cheapest choice on the market. If you’re goal is to pay the absolute lowest interest then you’re better off going with a variable rate mortgage. That being said, the forecast suggests that rates are set to jump again in 2018, so you must be prepared to take the risk, and it may very well be costly.
- You’re a short-term settler
If you are thinking of moving location in the next five years or are buying a small place now with the hopes of upscaling in the next few years, there’s a high chance that you should be looking at an adjustable rate mortgage.Your home equity will increase faster if you decide to go down the ARM route.
- You can pay quicker
If you can manage repayments for your house comfortably in a less than five years, then I’d steer clear of this option. There is a penalty for paying off sooner and you’ll get better interest rates in shorter term mortgages such as a two or three year fixed rate.