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Locking In a Mortgage 5 or 10 Years?

Locking in: Will it be a 10-year or 5-year mortgage?
Which side of the mortgage question are you on? 

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Mortgage debates used to centre around whether to go fixed or variable but the discussion these days is not whether to lock in a rate but for how long?

Variable rate mortgages have slumped in popularity over the last few months as discounts off of the 3% prime rate are either shrinking or disappearing. At the same time, financial institutions have dropped rates to as low as 2.99% for terms as long as four or five years.

But there is a new entrant to the marketplace - the 10-year mortgage. The Canadian Association of Accredited Mortgage Professionals says 10-year mortgages are about 1% of the marketplace but that may change as rates for the decade-long term have dropped to an all-time low with some lenders said to be offering an interest rate of 3.84%.

The choice is ultimately a personal decision and highly dependent on your risk tolerance. While variable represents the most risk, given its floating rate nature, the 10-year represents the ultimate in security coming with the heaviest insurance premium - albeit with a much lower cost these days.

One key factor about the 10-year that people forget is that under Canadian law you can only be forced to pay three months interest, after five years, to break a mortgage. That's a much lower penalty than the interest rate differential which can be in the tens of thousands of dollars.

Personally, I'm going to go with the five-year model. I like the 2.99% rate offered these days and even if it comes with restrictions like a 25-year amortization, you'll end up paying your mortgage down faster.

You could face limits on prepayment terms of 10% of the mortgage per year but if you have, say, a $500,000 mortgage, what are the odds you'll have more than $50,000 kicking around? You only increase monthly payments by 10% but odds are that will be enough for most people.

If you do choose a 10-year mortgage, one issue to consider is how portable that mortgage is should you want to sell or move. You might also ask if it's assumable by the buyer because if rates do go up, and you want to sell your home, a cheap mortgage could become a marketable commodity. The Financial Post asked several people in the industry to pick between a five-year and 10-year mortgage.

Ted Rechtshaffen, certified financial planner with TriDelta Financial, says he just had the debate with a client and, based on his math, if you think rates are going to be higher than 4.7% in five years you should lock in for the 10. "If you can do a five-year mortgage at 3.14% or a 10year at 3.89%, the renewal rate is going to have to be lower than 4.7% for you to be mathematically better off doing five years as opposed to 10," says Mr. Rechtshaffen. "It's not going to take a lot to get to 4.7% in five years, that's a historically low rate. I would suggest the odds are good you are going to have a mortgage rate that is 5% plus. My client was also asking about investment property and, to be able to lock up the investment rate risk for 10 years, that has considerable value."

Brian Johnston, president of home-builder Monarch Corp., says he'd go for the 10-year product. He'd opt for the same length for commercial money, too. "If I could get a 10-year at 4%, I would take that all day long. I said to my wife 'let's just go get a mortgage' and she said 'we don't need a mortgage.' I said 'it's 10year at 4%.' Interest rates will go up, we all know that, we just don't know when. Give me 10 years and I think I'll get it right," says Mr. Johnston. "It's unheard of to lock in money for 10 years at these rates. It's not going to last long."

John S. Andrew, adjunct assistant professor at Queen's University's School of Urban & Regional Planning & School of Business Queen's University, is leaning towards the 10-year. "I'm biased towards the 10 just because I think rates are going to go up considerably in that sort of time frame," says Mr. Andrew. "The only reason I would say don't go for 10 is in the rare circumstance where someone is going to pay down their mortgage in less than 10 years. For most people, the lifespan of the mortgage is going to be more than 10 years. We know these are historically low rates. Even though you are paying more for the 10-year than the five, it is going to prove to be a really good deal and why not lock in it for as long as possible. It's going to look like a sweet deal by year three."

Doug Porter, deputy chief economist with Bank of Montreal, says it's a close call but he's leaning towards a five-year mortgage. "It's a tight decision between the five and the 10. They are both exceptional offers. Purely as an economist, I have gone through what we would have to assume for the Bank of Canada on medium-term rates and it's a close call. For someone who does have a lot of financial flexibility, that certainty is a good thing. There is an outside risk the global economy could be hit with an inflation check in the next 10 years given the huge amount of government debt outstanding and today's rates will look laughingly low. Based on a traditional outlook, the five is slightly superior."

Vince Gaetano, principal at Monster Mortgage and a long-time proponent of variable-rate mortgages is a convert to the 10-year. "The product itself is no longer just a product, it's a plan and a strategy to get rid of debt," says Mr. Gaetano. "People should strongly consider taking on a 10-year product, especially individuals maturing from the 2007 market and who are coming out of 5.1% to 5.7% products. Keep your payments based on the same rate and take a 10-year and your mortgage will drop in half by the end of the term."

Farhaneh Haque, director of mortgage advice and real estate-secured lending at Toronto-Dominion Bank, sounded a little torn on choosing between the two terms. "You have to understand whether that home is something you are going to look to live in for the long haul," says Ms. Haque. "The rates are in your favour if you want to live somewhere for the long haul and you want to budget around your income. The 10-year could make sense. If you feel you are going to be moving and your life may be changing, you consider the five year."

Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth Management, says he would go five years. "While there is potential for interest rates to rise over the five-year term of the mortgage, they would have to rise significantly for me to have been better off potentially overpaying during the first five years of a ten-year term. That being said, choosing the ten -year rate is essentially buying insurance and peace of mind, which is a valid option for many Canadians," says Mr. Golombek.

Michael Polzler, executive vice-president, RE/MAX Ontario-Atlantic Canada, didn't pick between the two but says long-term mortgages have taken over the market. "While variable-rate financing has been the favourite child of real estate consumers to date, longer term, locked-in mortgages can provide greater peace of mind for homebuyers who can't afford an upward spike," said Mr. Polzler. "Today's five-and 10-year closed terms, available at unprecedented rates, are ideal for purchasers who want the security of a fixed monthly payment. For those considering this option, the timing has never been better."

Moshe Milevsky, professor at York University, thinks the ultimate question of whether to go five or 10 years needs to considered in the light of your overall finances. "In these extraordinary economic times, I believe that history is less relevant for the purpose of forecasting or projecting future interest rates. Indeed, the volatility of shortterm rates in the last few years has been close to zero. But it would be ridiculous to extrapolate that volatility is dead. If anything, the risk of a 'pop' in rates is ever growing," says Mr. Milevsky. "I believe that Canadians should first and foremost take a comprehensive approach to what I like to call 'debt allocation.' The type of debt you take, its maturity, quantity and flexibility should be determined in conjunction with the rest of your personal balance sheet. Period."

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