It is only in the last couple of years that a five year fixed rate become a product worth considering when it comes to paying the least amount of interest on your mortgage. 

Studies show that short term mortgages are the cheapest way to finance a house.

Historically, variable rate and short term fixed rates have had lower rates than long term rates. And yet, the big six banks, the Federal govt, and several popular finance experts have preached five year fixed –  ‘You must take five year fixed so you know what your rate is.’ 

While it is true that over the past two years, five year fixed rates did make more sense given low fixed rates and the spread between variable and fixed was less than 1.00% – even one and two year fixed rates were also not meeting that rate spread. 

The reason I use the 1.00% target spread between fixed and variable (Prime +/- discount) is because if you look at Prime’s movement history over the last five years, specifically at the six month rolling change) the maximum change is a 1.00% decrease over six months (the maximum increase is 0.54%) with the average change around 0.03%.  This means that you will need successive BIG changes in prime for your variable rate to match the fixed rate you would have gotten when you signed on the dotted line.  

Additionally, again looking back at the last 10 years, prime has changed 26 months out 120 months so it goes unchanged more often than it changes.

The biggest reason to stay away from fixed rate mortgages, specifically longer terms, is the inflated penalty calculation that lenders use. Variable rate mortgages have a maximum penalty of three months – but be careful on how this is calculated, some lenders will use your discounted rate but others will use the higher of your rate or prime.

But today, we have a new product to consider … a one year fixed can be had for 2.74% and a two year can had for 2.69% and although a fixed term, the penalty is not as restrictive because the term is not a long.

Short term fixed products are as appealing, or even more so than the current best discounts off of Prime/Variable rates (currently at 2.40%-2.50% for a five year variable). Some believe that better Variable pricing is on the horizon in the next 12 to 24 months. But even if that doesn’t happen, you will still be saving yourself almost 0.70% (with current fixed rates around the 3.39% range) a year for two years – a savings of over $4,000 in two years on a $300,000 mortgage. Not bad. 

What do you do in two years when your short fixed term ends?  Renew into a Variable!  If analysts are correct and deeper discounts off prime are on the horizon, Variable rates will continue to be the winner over the long term!

Is this a risky move?  Yes, of course!  No one can predict the future but you also can’t argue with statistics.  

If you are risk adverse, by all means, stick with a longer term.  Current five year rates are still below the five year average as are seven and 10 year rates but always remember … penalties, penalties, PENALTIES!  These will make the total cost of borrowing sore if you are unsure of what the next few years bring.

Remember, stats tell us that Canadians change their mortgage every three years on average. The secret to survival is to plan for the worst. 

I don’t know about you, but I’m tired of seeing Canadians hit with $10,000-$20,000 in penalties. 

If you’re unsure and would like to see it in black and white, please give me a call and I can show you how much you can save by going with a shorter fixed term or a variable rate mortgage.  This kind of analysis can even make you less risk adverse.

Also check out Canadian Mortgage Trends for the latest on fixed and variable rate mortgages in Canada.