3-year mortgages typically carry 20 to 40bps (1 basis point is equal to 0.01%) lower interest rates than 5-year terms. Starting late 2022, this gap has shrunk further and even reversed, with lenders offering 3-year rates that are higher than 5-year rates. Usually, 3-year rates are lower, and the discount you get with a 3-year mortgage term can still provide significant savings in your monthly mortgage payments.
You should choose a shorter mortgage term if you anticipate interest rates to decrease soon. A shorter term would allow you to renew your mortgage at lower interest rates. However, if your expectations are unmet, you may be in for a stark surprise with a need to renew at higher interest rates.
Generally, experts suggest opting for shorter terms when rates are expected to decline, whereas longer terms are more appropriate when rates are predicted to rise. If you’re risk-averse, we advise locking into today’s lower rates with a 5-year, 7-year, or even a 10-year fixed term to protect against rising rates. However, if you can withstand some risk, locking into the best 3-year fixed mortgage rate could be the most suitable option to save you money in the current restrictive rates market.
There are penalties for breaking your mortgage early. In most cases, the penalty is three months’ worth of interest. However, with fixed rates, it could also be the higher interest rate differential (IRD) penalty calculation. The IRD allows the lender to partially crawl back interest that they would have made if you had continued to make interest and principal payments to the end of your term.
The IRD penalty is a contentious issue on fixed-rate mortgages as the Big Banks use their posted rates to calculate this penalty – making it much costlier to break your mortgage and thus keeping borrowers captive for longer. Your penalty ranges from a few thousand dollars to tens of thousands of dollars, depending on your lender, the time remaining to complete your term, the discount you received, and if the current rates are higher or lower than yours.
You should choose a shorter term if your plan involves moving out of Canada or expecting an inheritance you’d like to use to pay off your mortgage sooner. Find a lender with suitable mortgage porting terms if you expect to switch homes before your longer term ends.