Ottawa — With mortgage rates at their highest in more than a decade, homeowners and potential buyers tend to focus on getting the best interest rate. However, experts point out that we must not forget about another important element of mortgage loans: the length of the term.

Samantha Brookes, founder and CEO of Mortgages of Canada, says that before the Bank of Canada started raising interest rates last year, a five-year loan was the norm for most homebuyers. That has changed, however: people are now shortening this term in the hope that interest rates will fall in the coming years.

“That makes sense because if, for example, the Bank of Canada starts cutting rates next year and you’re on a three-year contract, you’ve only got two years left,” she says.

“If you break your mortgage, you have to pay a two-year penalty, but your interest rates are much lower and your payments are more affordable. That’s why people are opting for the shorter-term mortgage right now.

The “term” of a fixed-rate mortgage is the contract term with a fixed interest rate for a loan. If the loan is not repaid in full by the end of the term, you will have to renew your mortgage for a new term at prevailing interest rates. This duration differs from the payback period, which is rather the total time required to repay the loan.

Shorter, more popular

Mortgage rates rose steadily as the Bank of Canada raised its interest rate target. The central bank’s interest rate, which was 0.25% at the beginning of last year, is now 4.75%.

According to interest rate tracking website Ratehub.ca, five-year discount mortgage rates in Canada are at their highest since early 2009. Five years ago, they are now renewing their loan at higher rates than when they bought their home.

In its Spring Residential Mortgage Report, the Canada Mortgage and Housing Corporation (CMHC) reported that fixed-rate loans with maturities of five years or more accounted for just 13% of new mortgages, while three-year ones accounted for 36%.

In January 2020, before the pandemic, fixed-rate mortgages with maturities of five years or more accounted for 46% of mortgages.

Meanwhile, adjustable rate mortgages accounted for just 16.7% of new and renewed mortgages in January 2023, down from 56.9% in January 2022.

Disadvantages

Choosing a shorter term is not without its downsides.

According to Rateub.ca, the best rates for three-year mortgages are higher than the best available deals for five-year mortgages. And if the rates don’t go down or up, all hope of being able to benefit from the lower rates when you renew is lost.

Still, Jimmy Aramouni, Royal Bank’s mobile mortgage specialist, says clients who consult him are more inclined to take shorter maturities and wait and see how interest rates develop.

However, Mr Aramouni says it is important for buyers and homeowners renewing their mortgages to also understand their plans for their home for years to come when deciding on the term.

“Are you going to stay in this property, expand it, sell it, or buy another one?” he asks.

“The other important point is the monthly mortgage payment. How much can they afford each month? Because every term has its own tariff.”

Mr Aramouni pointed out that it is important to consider the term because if you find yourself in a situation where you have to cancel a mortgage loan before the term expires, you end up paying a penalty.

“We recommend clients to sit down with their mortgage specialist, talk to him (…) and then seek advice.”