You have two choices when choosing a mortgage term:
- Short-term rate protection, i.e., a:
■ Variable rate
■ 6-month fixed
■ 1-year fixed
■ 2-year fixed
- Long-term rate protection, i.e., a:
■ 3-year fixed
■ 4-year fixed
■ 5-year fixed
■ 6- to 10-year fixed
Whether you go short-term or long-term depends largely on 5 things:
1) Your ability to financially handle rate increases
- Can you withstand a 2-3 percentage point rate hike
■ Rate hikes could happen during your term (if you take a variable) and at renewal
■ A 2-3 percentage point hike could increase your payments roughly 24-37% - Do you have stable employment and income?
■ The risk of higher payments increases if your income might drop - For more, see “I.D.E.A.S. for choosing fixed vs. variable“
2) Your faith in the past
- Shorter-terms have proven less costly the majority of time, historically
- Rates go up and down in cycles, and when they increase, they don’t increase forever
3) Your psychological risk tolerance
- If rates start increasing every few months will you panic and lock into a high fixed rate?
■ You will virtually never get the best rates at the time you lock in
■ Successfully timing interest rates is practically impossible
■ If you plan to eventually lock in, you’re usually better off with a fixed rate from the start
4) The spread between short-term and long-term rates
- Your odds of success with a longer term are arguably higher if:
■ The spread between long and short-term rates is small (e.g., less than one percentage point)
■ Rates are in a cyclical trough
5) The likelihood of you needing to refinance
- Breaking a closed mortgage early entails penalties
- If there is a chance you’ll need to renegotiate your mortgage in the next 1-3 years, a longer term may not be appropriate
- Common reasons to break a mortgage early include the need to:
■ Sell your home
■ Refinance into a lower rate
■ Borrow more money (e.g., increase your mortgage to pay off debt, start a business, fund education, etc.) - Note: With a longer term, you can often port your mortgage to a new property or blend the rate (if you request more money), but then you’re stuck with whatever terms the lender gives you. If the lender knows you’ll pay a penalty to leave, it might not negotiate with you.