When it comes to your mortgage financing, two of the most important decisions you’ll make are which mortgage rate type and term you want to go with. Would you prefer a fixed or variable rate? Do you know the differences between the two and how they will affect both your budget today and in the future? And how long do you want to keep that rate type for? Each combination of rate type and term makes sense for different reasons. To help shed some light on this topic, we interviewed Canadian homeowners to see which mortgage types and terms they chose and why. Today, let’s look at what a 3-year fixed rate is and who is choosing them.
What is a 3-Year Fixed Rate Term?
A fixed mortgage rate is simply an interest rate that you lock into. Unlike a variable mortgage rate, a fixed rate is not attached to the market, so it can’t fluctuate up or down – what you sign up for is what you get. With a fixed rate, you will always know exactly how much your monthly mortgage payment will be, which is great for budgeting purposes. And the “term” is simply the length of time you lock into that rate for – in this case, 3 years.
According to the Canadian Association of Accredited Mortgage Professionals (CAAMP), 20% of all Canadian mortgage-holders have terms between 2 and 4 years. While the most popular mortgage term is 5 years, a shorter mortgage term may be a better choice if you think there’s a chance you’ll break your term in the next few years (because you need to move, upgrade, sell, etc.). Breaking a shorter mortgage term will result in a smaller prepayment penalty.
One thing to consider is that, even if you qualify for your lender’s 3-year fixed rate, you will still need to qualify for their higher 5-year fixed rate. All lender’s use their 5-year fixed rate as their “benchmark rate” to qualify borrowers with, so they can prove you will have a little breathing room in your budget, in case you lost some income or interest rates increased by the time your term came up for renewal.
Features of a 3-Year Fixed Rate Term
Here are some features of a 3-year fixed rate mortgage, which may or may not be reasons to choose it for your next mortgage term:
- Your mortgage rate and payment amount stay the same for 3 years, which is great for budgeting purposes
- Unfortunately, your rate is often higher than what you could get with some shorter terms or variable rates, meaning you’ll pay a premium for the stability of your fixed rate
- It can be a great length of time to commit to a mortgage term, if you’re worried there’s a chance you’ll have to move/sell in the next 3-5 years
- However, if you have to sell before your 3-year term is up, you have to pay a prepayment penalty, which is the greater of three months’ interest and the interest rate differential (IRD)
- Even if you qualify for the 3-year fixed rate, you still need to qualify for your lender’s 5-year fixed rate (their benchmark rate), which will be higher
Profile of a 3-Year Fixed Rate Term Mortgage Holder
We learned before that a homeowner would choose a fixed rate for the stability of the interest rate and payment amount. But if you think interest rates could go down in the future, you may want to choose a term that is shorter than the most common one, which is 5 years. Read our interview with Virginia, to find out why she and her husband chose a 3-year fixed rate term for their mortgage:
What type of home did you buy and in which city?
We bought a 3-bedroom, 1 1/2-bathroom semi-detached home in Moncton, New Brunswick.
When did you buy your home and what was the purchase price?
We purchased in November 2008 for $145,000.
Did you choose a fixed or variable interest rate? Why?
At that time, we chose a fixed rate, because the market was in flux and we were afraid rates would go up. We renegotiated our mortgage in 2013 and stayed with a fixed rate, because rates were low and there was talk that they would go up in 2014.
What interest rate did you get?
In 2008, our mortgage rate was 5.44%. In 2013, we got a new 3-year fixed rate of 2.89%.
Were you happy with your interest rate in 2008?
We were not at all happy with our interest rate in 2008, because Prime rate dropped significantly just a few months later (from 4.00% to 2.25% between November 2008 and April 2009). As soon as our first mortgage term was up (2013) and we could renegotiate without penalty, we did. And we’re really happy with our current mortgage rate.
Why did you choose a 3-year term?
The 3-year term offered the best combination of a low rate for a good length of time. We could have gotten a better rate for a shorter term, or a higher rate for a longer term, but 3 years felt right (especially considering how much interest rates changed during our first 5-year term).
What factors influenced your decision?
We knew that Prime rate had been 3.00% for a few years, but understood that would eventually change. So, we wanted to take advantage of low rates while we could, but didn’t want to lock into a term as long as our last one (5 years) because of how interest rates had changed during that amount of time. With our current mortgage rate and product, we also have room in our budget to pay more than our minimum mortgage payment each month; this is helping us build up our equity and pay down our mortgage faster.
Would you choose a 3-year fixed term again? Why or why not?
We would definitely chose a 3-year fixed term again – depending on future interest rates and projections, of course.