3-year term

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Mortgage terms in Canada can vary from six months to 10 years. Though three-year terms aren’t the most common of the bunch, they are chosen by 20% of borrowers, according to the Canadian Association of Accredited Mortgage Professionals. And, they can offer a range of benefits.

One of the most appealing aspects of a shorter loan term, like a three-year, is flexibility.

While homeowners often have heady fantasies of finding their forever home on the first try, 7 out of 10 repeat homebuyers move sooner than they expect, according to a survey from TD Canada Trust.

“The biggest advantage of a three-year to the consumer is a shorter timeline in case they don’t know what their long-term strategy is with their mortgage going forward,” says Frances Hinojosa, managing partner at Tribe Financial. “It gives them a safety net of knowing, at a very good interest rate, that they could pause at [the three-year] point and reconsider their options.”

Three-year loans usually come with lower interest rates — which sounds great at first, but not so much once you consider why that is.

Lenders offer lower rates on shorter-term mortgages as a way of balancing out your risk of facing a higher rate in just three years, when the term ends.

Three-year fixed mortgage rates have historically tracked lower than their five- and 10-year counterparts, but from June 2020 until early March of this year, they were averaging higher than five-year fixed rates. Do some comparison shopping to find a lender offering the best three-year mortgage rates today.

5-year term

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The five-year fixed rate mortgage is the granddaddy of mortgages in Canada. It’s the product that gets pushed hardest by the biggest banks and, because of that, it’s the loan term most borrowers gravitate towards.

You’ll generally pay a higher interest rate on a five-year term than you will on a three-year. That’s the trade-off for having an extra two years of stability. The predictability of knowing what your mortgage payment will be for the next 60 months can be pretty enticing for homeowners on a budget, and may be worth sacrificing a few basis points on your mortgage rate. One basis point is one-hundredth of 1%.

“It’s a good, middle-of-the-road long-term-rate hold,” Hinojosa says.

Stability also is something your lender will be looking for when approving your loan. A lender is banking — pun intended — on collecting five years' worth of interest from you, so if you break your agreement and pay off your mortgage early, expect to feel some pain.

Weigh the risks before you sign

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This is one of the biggest risks of agreeing to a five-year mortgage: If your plans unexpectedly change and you need to sell your home, transfer your mortgage or break your mortgage contract, you could be on the hook for a colossal prepayment penalty.

Your penalty will be either three months of interest on the amount you still owe, or what is known as the interest rate differential (IRD), a rather complex calculation your lender will base on multiple interest rates. Let’s just say that the IRD is usually much larger than three months' interest — by thousands — and that lenders almost always ask for the IRD amount.

One homeowner who recently broke a five-year fixed-rate mortgage with CIBC had to pay over $47,000 in prepayment fees. Hinojosa once encountered a prepayment fee of $280,000. That mortgage was in the millions, but the lesson’s the same for any loan amount.

“Know the features, know the cost,” Hinojosa says. “And ensure that it’s something that, if you’re going into for five years at a fixed rate, you are staying committed to.”

The five-year fixed market is one of the most competitive in the Canadian mortgage space. In early March, several mortgage rate comparison sites reported that the lowest rate for a five-year fixed-rate mortgage rose one quarter of 1 percentage point (0.25) to 1.64%, the first such increase since January of last year.

As Canada's major banks have raised their mortgage rates of late, you may want to move fast to secure a favourable rate if a five-year is the term you're after.

10-year term

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A choice for approximately 5% of Canadian homeowners, the 10-year mortgage term isn’t going to win any popularity contests. But when you’re weighing your options, it’s worth taking a few minutes to ensure you’re getting their full heft.

A 10-year mortgage term is a relatively safe choice if you're unlikely to move or sell for an extended period of time. The peace of mind that comes from knowing your mortgage payment won’t increase for a full decade is considerable, and something five- and three-year mortgage holders don’t get. That’s why these longer-term loans will cost you more in interest.

But 10 years, even for homeowners who have zero intention of disrupting their current, comfy lifestyles, is a long time to plan for.

"No one has a crystal ball,” Hinojosa says. "Life happens, and you never know what’s around the corner."

Breaking a fixed-rate 10-year mortgage after the first five years will cost you three months of interest, but breaking it during the first five could trigger a massive prepayment penalty that dwarfs those associated with five-year terms.

“The times that I have seen clients take 10-year terms where it made sense were investment properties where there is a 10-year option, because then you’re going to have stability of cost versus income coming in for that long-term hold,” Hinojosa says.

Next steps in your mortgage journey

Once you’ve determined which mortgage term is best for your financial needs, you’ll be better prepared to compare what lenders are offering, not only in terms of mortgage rates, but also in terms of the additional fees and conditions that will determine the ultimate cost of your mortgage.

“Chase the solutions, not the cost,” Hinojosa advises, “because that’s where you’re going to have the most savings in the long run.”

When you've decided what type of mortgage works best for you, compare rates and loan offers from multiple lenders to find the best loan and lowest mortgage rate available to you.

And the better your credit score the better your rate. Anything above 760 is excellent. Today, it's easy to check your credit score for free online.

About the Author

Clayton Jarvis

Clayton Jarvis

Reporter

Clayton Jarvis is a mortgage reporter at MoneyWise. Prior to joining the MoneyWise team, Clay wrote for and edited a variety of real estate publications, including Canadian Real Estate Wealth, Real Estate Professional, Mortgage Broker News, Canadian Mortgage Professional, and Mortgage Professional America.

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