Mortgage Basics #Guides #Renewal and Refinancing
Mortgage Basics #Guides #Renewal and Refinancing
Cost Savings with a 5-Year vs. 3-Year Fixed Mortgage Rate
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Many Canadian homebuyers find it challenging to decide between a 3-year fixed-rate mortgage and a 5-year fixed-rate mortgage. If you’re a homebuyer or homeowner up for a mortgage renewal, our guide can compare cost savings using current rates.
While both options have benefits and drawbacks, your financial circumstances, unique needs, risk tolerance, and personal economic outlook determine which term best suits your mortgage strategy.
Key Highlights
- Both 3-year and 5-year fixed-rate mortgages offer unique advantages and challenges.
- Your personal financial goals, market predictions, and risk tolerance should dictate your decision between the two.
- A detailed cost-benefit analysis of various scenarios can clarify the potential outcomes and aid decision-making.
Choosing Between Fixed and Variable Mortgages
Before we deep-dive into the specifics of 3-year and 5-year mortgage terms, it’s crucial to understand the fundamental distinction between fixed and variable mortgages.
- In a fixed-rate mortgage, the interest rate and payment remain constant throughout the term, providing borrowers with stability and predictability.
- On the other hand, in a variable-rate mortgage, the interest rate fluctuates with changes in market interest rates, which can either work in the borrower’s favour or against it.
You should base your choice on your risk appetite, market predictions and short- and long-term financial situation expectations.
Why Opt for a 5-Year Fixed Rate Mortgage?
Historically, the 5-year fixed-rate mortgage has been the go-to choice for many Canadians.
But why is that?
Lenders advertise and discount their 5-year rates more often than other rates they offer, but this option’s primary allure lies in its stability. With a 5-year term, borrowers can enjoy peace of mind with predictable monthly payments.
Stability and predictability can be quite a relief in fluctuating market conditions such as the last 18 months and those forecasted recently by the world’s central bankers. However, this security does come at a cost, as 5-year mortgages lock you in for longer than their 3-year counterparts.
Pros of a 5-Year Fixed Rate Mortgage
- Stability: The fixed interest rate for a 5-year term means your mortgage payments remain unchanged for the entire duration. Stability can be especially beneficial for budgeting purposes.
- Security: The longer-term commitment offers a sense of security, shielding you from sudden changes in interest rates.
- Less Frequent Renegotiation: With a 5-year term, you won’t have to renegotiate your mortgage as frequently, saving you time and potentially money.
Cons of a 5-Year Fixed Rate Mortgage
- Limited Flexibility: A 5-year fixed rate doesn’t offer much flexibility, unlike a 5-year variable rate, which allows for early renewal (conversion) into a fixed rate term equal to the remaining term of your variable mortgage without penalty.
- Risk of Missing Out: If market interest rates fall, you’ll be stuck paying the higher rate until your term ends.
- Higher Penalties: If you must break your mortgage contract early, prepare for a prepayment penalty. Not all penalties are equal; however, some lenders offer a fair and transparent penalty calculation, but not all. Interest rate differential (IRD) penalties on fixed mortgage rates increase when paying out a mortgage with a currently higher rate in a lower rate environment.
The Appeal of a 3-Year Fixed Rate Mortgage
A 3-year fixed-rate mortgage might not be as popular as its 5-year counterpart, but it has gained traction among Canadian borrowers.
The shorter term offers flexibility, making it an attractive option for those with uncertain plans or those predicting a drop in interest rates within 3 years.
Pros of a 3-Year Fixed Rate Mortgage
- Competitive Interest Rates: Historically, lenders have offered slightly lower rates on shorter-term mortgages than 5-year mortgages. However, this relationship has inverted as money markets expect inflationary pressures to subside over the longer term. Every lender’s discount is different, so it’s recommended that borrowers shop around when they come up for renewal before accepting their lender’s first offer.
- Flexibility: With a shorter commitment, you can reassess your financial situation and adjust your mortgage terms more frequently.
- Lower Penalties: If you need to break your mortgage early, the penalties associated with a 3-year fixed mortgage term are typically lower than for longer-term mortgages. This lower penalty allows you to take advantage of sudden life changes, other financial opportunities, or changes in your financial situation.
Cons of a 3-Year Fixed Rate Mortgage
- Less Stability: The shorter term means more frequent exposure to interest rate fluctuations. Many lenders do not offer a discount from their posted rates at renewal time, so you must shop around!
- More Frequent Renegotiations: A 3-year term requires you to renegotiate your mortgage more often, which can be time-consuming and potentially costly.
- Uncertain Future Payments: If market rates rise upon renewal, you could face payment shock with higher mortgage payments.
3-Year vs. 5-Year Mortgages: Which One Is Right for You?
The choice between a 3-year and a 5-year fixed-rate mortgage boils down to your circumstances and financial goals.
- A 5-year fixed-rate mortgage might be your best bet if you desire stability and predictability.
- Conversely, a 3-year fixed-rate mortgage could be the way to go if you prefer flexibility and the potential to benefit from lower interest rates sooner.
Mortgage rates can fluctuate rapidly and unexpectedly due to the Canadian and US economies and bond market expectations in response to inflationary pressures.
It is advisable to work with a mortgage expert who can navigate the market with you and assist in selecting the most suitable mortgage for your specific requirements. A licensed mortgage expert can also help you compare rates from various lenders to ensure you secure the most favourable deal.
Opting for a lender like nesto, which promotes the lowest rates on their website, can help you steer clear of intermediary salespeople who may not prioritize your best interests. Dealing directly with a lender can also help you avoid origination fees and prevent product recommendations from being influenced by the salesperson’s potential commissions.
Analyzing the Impact: 3-Year vs. 5-Year Mortgages
Let’s explore five hypothetical scenarios to understand how your choices may impact your savings in the next five years. This analysis will assist us in estimating the potential amount of money you could save by selecting one option over another.
These scenarios and calculations are based on an insured 3-year fixed mortgage rate of
Scenario 1: Rates Remain the Same Through End of Term
In the first scenario, rates stay the same til the end of the 5-year term. If you had chosen the 3-year fixed term, you would have decided on another term when your mortgage is up for renewal.
Scenario 2: Rates Drop by 0.75% in Year 4
In the second scenario, rates decreased by 0.75% in the 4th and 5th years for the 3-year fixed mortgage. If you had chosen the 3-year fixed term, you would have decided on another term when your mortgage is up for renewal.
Scenario 3: Rates Drop by 1.00% in Year 4
In the third scenario, rates decreased by 1.00% in the 4th and 5th years for the 3-year fixed mortgage. If you had chosen the 3-year fixed term, you would have decided on another term when your mortgage is up for renewal.
Scenario 4: Rates Decrease by 1.50% in Year 4
In the third scenario, rates decreased by 1.50% in the 4th and 5th years for the 3-year fixed mortgage. If you had chosen the 3-year fixed term, you would have decided on another term when your mortgage is up for renewal.
Scenario 5: Rates Decrease by 2.00% in Year 4
In the last scenario, rates decreased by 2.00% in the 4th and 5th years for the 3-year fixed mortgage. If you had chosen the 3-year fixed term, you would have decided on another term when your mortgage is up for renewal.
We hope these scenarios have illustrated that locking into an extended period offers stability and predictability for a longer period when rates are expected to rise. However, locking into a shorter term provides flexibility and savings if rates are expected to decrease by more than 1% over the term.
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FAQs on 3-Year vs. 5-Year Mortgage Savings
Is it better to get a 3-year or 5-year mortgage?
The better choice depends on your circumstances, prospects, and risk tolerance. A 3-year mortgage offers greater flexibility and potential savings if interest rates drop, while a 5-year mortgage provides stability and protection against rising rates.
Which mortgage term length is better when interest rates increase?
If you anticipate a rise in interest rates, a 5-year fixed-rate mortgage might be more beneficial. The longer you lock into your interest rate, the more protection you have from potential rate increases.
Which mortgage term length is better when interest rates decrease?
If interest rates are expected to decrease soon, a 3-year fixed-rate mortgage would be better. This shorter-term commitment allows you the flexibility to take advantage of lower rates sooner.
Final Thoughts
Choosing between a 3-year and a 5-year fixed-rate mortgage isn’t a one-size-fits-all decision. It depends on various factors, including your financial situation, plans, and risk tolerance.
Mortgage experts can provide advice tailored to your unique circumstances and help you navigate the complex world of mortgages. Remember, informed decisions make for better long-term financial health.
If you’re renewing your mortgage or buying your first home, contact nesto’s mortgage experts to find the most suitable mortgage and rate for your situation. Reach out today, and we’ll connect you with one of our mortgage experts to answer all your questions.
Why Choose nesto
At nesto, our commission-free mortgage experts, certified in multiple provinces, provide exceptional advice and service that exceeds industry standards. Our mortgage experts are non-commissioned salaried employees who provide impartial guidance on mortgage options tailored to your needs and are evaluated based on client satisfaction and advice quality. nesto aims to transform the mortgage industry by providing honest advice and competitive rates using a 100% fully digital, transparent, seamless process.
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