This is the 8th article in our Mortgage Life Cycle Costs series.
As a reminder, Canadian banks are a saturated oligopoly. Oligopolists are interdependent of each other and usually don’t risk competing by price [interest rates], instead they compete by image, retention, etc. Consequently, in our Mortgage Life Cycle Costs series, we caution you that an over-focus on interest rates may blind you to other mortgage factors that can cost you a lot more than the difference between two mortgage interest rates.
Why write these articles? We have seen many people suffer loss, because of an over-focus on interest rates. We believe you can make better mortgage choices when you know and understand critical information about mortgages.
In this article we will cover the mortgage term. With mortgage “term” I mean the length of time your mortgage agreement and interest rate will be in effect and not the “terms” of the terms and conditions of your mortgage. You may be wondering why spend an entire article on the mortgage term? Precisely because the mortgage term is so inconspicuous it is often misunderstood, neglected by borrowers, and used by financial institutions for their benefit. When you know more about your mortgage term and options you can use it to protect you against risk, include it in your mortgage planning and prevent your bank or broker from offering you a mortgage term based solely on the mortgage interest rate.
In some countries the mortgage term and amortization are the same, but in Canada they are usually different. Let’s define them so we are on the same page:
- Amortization Period: This is the length of time it would take to pay off a mortgage in full, based on minimum mandatory payments at a certain interest rate. Depending on your down payment, mortgage type, etc. most prime mortgage amortization periods can be up to 30 years. [We will cover the amortization period in a separate article]
- Mortgage Term: The mortgage term is the length of time your mortgage agreement and interest rate will be in effect. Unless it is your very last term, your mortgage is usually not paid in full, and you will need to renegotiate a new mortgage term at the end of your mortgage term. Term lengths usually range from 6 months to 10 years and the term type can be partially open, fully open or fully closed.
Let’s define a few more terms before we continue:
- Maturity Date: Also known as the renewal date, this is the date on which your mortgage term expires and your new mortgage term starts.
- Prepayment Penalty: If you exceed your prepayment privileges or break your mortgage agreement you may be subject to a prepayment penalty. The prepayment penalty depends on many things e.g. lender, lender type, term type, mortgage size, interest rate, penalty calculation methods, interest rate type, etc.
Let’s look at what you need to know about your mortgage term
Because all lenders refer to the same terminology, e.g. mortgage term, it is easy to assume that mortgage terms are universal for all lenders. This is NOT true, each lender determines its own terms and conditions, so buyer beware!
The first thing that usually comes to mind about the mortgage term is the term length, and although it may be the most obvious, there are many other important factors about the mortgage term you should also consider when choosing your most desired mortgage. Here are some important factors about your mortgage term:
1. Term Type:
Your mortgage term can be partially open, fully open, or fully closed. You may only be familiar with open or closed mortgage terms, but these mortgage industry colloquialisms are incomplete and not entirely correct. Your mortgage term type matters a lot and if you are not careful you can end up in a very limiting mortgage, so let’s look at the mortgage term types:
- Partially Open: You may not be familiar with this term, but most of the mortgages we consider to be “closed” are instead partially open. Partially open mortgages are the most common and usually preferred for long-term mortgages. Partially open mortgages have competitive interest rates, can have fixed or variable rates, provide the borrower with prepayment privileges and can usually be paid out before the term maturity date, subject to a mortgage penalty.
- Fully Open: These mortgages can usually be paid out without a prepayment penalty prior to the term maturity date. Open mortgages may have more flexibility, but you pay for that flexibility with significantly higher interest rates. Because of their higher interest rates, open mortgages are usually applicable to temporary, interim or shorter-term mortgages. e.g. Selling your home shortly after the term maturity date. Contrary to popular belief, open mortgages are not limited to variable rates.
- Fully Closed: Other than upon a bona fide sale, these mortgages can usually NOT be paid out at all prior to the term maturity date even if the borrower is prepared to pay a penalty. Fully closed mortgages can have fixed or variable rates and their limitations are usually disguised by slightly lower interest rates, so don’t just focus on your mortgage rate. Because of their very limiting nature you should avoid or at least be very cautious about these mortgages. Most of what the mortgage industry calls “closed” mortgages are usually partially open, so be careful to differentiate and determine whether your mortgage is indeed fully closed or partially open.
2. Rate Type:
Depending on your lender, circumstances, etc. you should be able to choose a fixed or variable interest rate mortgage. I have covered interest rate types, how to choose an interest rate type, etc. in a previous article so I won’t repeat it here. Please refer to that article for details. I would like to remind you not to choose a rate type because it is the lowest rate being offered to you. Financial institutions and brokers typically sell you the rate that will get them the deal, not necessarily what is best for you or meets your needs, risk profile, etc. I would like to remind you of the following:
- Market Trends: Although nobody has a crystal ball, consider market trends. g. be careful of a variable rate if the Bank of Canada predicts interest rate increases. Lenders will often incentivize sales people to sell mortgage products based on mortgage market trends – be careful of those products
- Risk: Don’t create risk where there is little risk for limited gain. Be true to your needs, personality, and risk profile.
3. Term Length:
Canadians are most familiar with the 5-year mortgage term, but other term lengths are also available depending on your lender, interest rate type, etc. choices. Here are some term length options:
- Fixed Rate Term Lengths: 6 months, 1, 2, 3, 4, 5, 7 or 10 years
- Variable Rate Term Lengths: 3 or 5 years. While other variable term lengths may be available, these are the most common.
To choose your term length, consider the following guidelines:
- When rates are lower, go longer. g. Be cautious of a lender enticing you with a slightly lower rate for a shorter term when rates are below average.
- When rates are higher, go shorter. g. It may not make sense to lock into a 10-year, fixed rate term when rates are above average.
- Mortgage Problems: Temporary circumstances such as credit, income, etc. may cause your mortgage options to be limited to alternative lenders. In these cases try to choose a term length long enough to rectify the problems so that you can move the mortgage to a prime lender.
- Circumstances: Nobody has a crystal ball, but honestly consider your circumstances at your term maturity date. g. Will you be able to afford your mortgage if rates increase when your mortgage term matures?
4. Mid Term Events:
Depending on your circumstances you may incur a mortgage penalty if you exceed your mortgage prepayment privileges or you payout your mortgage entirely prior to the term maturity date. Of all the mortgage life cycle costs mortgage penalties are the most prohibitive, so try your best to understand your mortgage penalties prior to entering into a mortgage contract. I have previously covered mortgage penalties in detail, so please refer to that article for details.
5. Mortgage Renewal:
You are obligated to renew your mortgage on the mortgage term maturity date. Here are important aspects to know about your mortgage renewal:
- Qualification: Under current mortgage rules you don’t need to re-qualify for your mortgage if you renew your mortgage with your current lender and you keep their mortgage unchanged. However, if you wish to move your mortgage to a different lender and/or want to make changes to the existing mortgage, you will need to re-qualify for the new mortgage.
- The Past Determines the Future: The current mortgage determines your future mortgage rate. E.g. Certain mortgage products will remove your future mortgage options and make you eligible for higher interest rates.
- Renewal Rates: Your mortgage is subject to market interest rates at the time of renewal and your lender has no obligation to match your current interest rates.
- The Lender Matters: Your existing lender and lender type is a large determinant of the interest rate you can expect for your new mortgage. g. Will you be offered posted or discounted interest rate at renewal?
- Renewal Terms & Conditions: Your lender has no obligation to maintain the same terms & conditions for your new mortgage. Your new mortgage can be very different to the existing, so be careful to read and understand the terms and conditions and move your mortgage to a different lender if you are not satisfied.
- Renewal Timeframe: Although some may start earlier, most lenders will start the renewal process 90 days before the term maturity date.
- Early Renewals: Some lenders may allow you to early-renew your mortgage before the term maturity date subject to a mortgage penalty. In most cases the mortgage payout penalty CANNOT be added to the mortgage, and you will need to pay the penalty from your own resources.
Choosing your next mortgage term shouldn’t be overly complex, but you should consider all the above before making a choice. Contact us with your mortgage needs. We are here to help.
- The opinions expressed in this article are the opinions of the author only and not of anyone or any other entity.
- Not legal, economic, financial or any other advice.
- Not for decision-making purposes.
- Subject to lender approval and terms & conditions
- In any and all cases of any conflict of any kind, lender rules, guidelines, terms & conditions, interest rates, etc., supersede these.
- Subject to change in any or all ways, at any time, without prior notification or warning.
- Does not include all, may exclude some and/or may only partially represent guidelines, mortgage rules, scenarios, topics, etc.
- These are general guidelines and are not specific to any particular mortgage lender. Lenders don’t all have the same products, underwriting guidelines, etc.
- Subject to all borrowers seeking independent professional advice from any and all providers as determined solely by the borrower, at the borrower’s own and sole discretion, prior to applying for a mortgage/loan.