When it comes to mortgages, two of the most important decisions you’ll make in regards to your financing are which mortgage rate type and mortgage term you want to go with. Should you choose a fixed or variable mortgage rate? And how long do you want to keep that rate type for? Each option makes sense for different reasons, and the decision can be very personal. For curiosity’s sake, we interviewed several Canadian homeowners to see which mortgage rate types and terms they were choosing and why. Today, let’s look at what a 5-year variable rate is and who is choosing it.
What is a 5-Year Variable Rate Term?
As we went over in our first post for this series, a fixed rate term is one where your mortgage rate and payment stay the same for a specific period of time. Homeowners choose fixed rate terms because they want to know what their payment amount will be for the entire length of their term; this helps with budgeting, but homeowners pay a premium (in the form of a higher rate, when compared to variable rates) to purchase the “stability” of this rate type.
With a variable rate, however, your interest rate is attached to Prime rate. When you sit down with a mortgage broker to discuss getting a variable rate, they’ll quote you a rate of Prime +/- a percentage. For example: Prime – 0.25%. If Prime rate fluctuates up or down, your mortgage rate – and, therefore, your mortgage payment amount – would fluctuate along with it. By choosing a 5-year variable rate term, you’re agreeing to commit to this mortgage rate type (and its potential fluctuations) for 5 years.
Features of a 5-Year Variable Rate Term
Here are some features of a 5-year variable rate mortgage term, which may or may not be reasons to choose it for your next mortgage term:
- Your interest rate is attached to Prime rate and, therefore, will fluctuate if Prime rate increases or decreases
- If your rate goes up or down, your mortgage payment amount will follow; for this reason, you need to have a cushion in your budget, to allow for a potential increase to your payment amount
- Some homeowners see the potential rate fluctuation that comes with variable rates as a risk, however, variable rates have historically proven to be lower than fixed rates over time
- 5 years is the most popular mortgage term among Canadian homeowners; it’s also the term with the lowest interest rate, compared to 1-year and 3-year variable terms, on our website
- If you had to break your mortgage term early, for whatever reason, your prepayment penalty would simply be three months’ interest; this is the same for all variable rate mortgage terms
Profile of a 5-Year Variable Rate Term Mortgage Holder
Based on this information, someone would have to be comfortable taking on a little bit of risk with their mortgage financing, in order to choose any variable rate term. Read our interview with Dayle, to find out why she went with a 5-year variable rate term for her first mortgage:
What type of home did you buy and in which city?
I bought a 3+1 bedroom, 2-bathroom semi-detached home in Oshawa, Ontario.
When did you buy your home and what was the purchase price?
I purchased in April 2011 for $174,000.
Did you choose a fixed or variable interest rate? Why?
I chose a variable interest rate because it was super-low at the time, and I knew that if it ever increased, I had the wiggle room available in my budget to accommodate the increase. However, I did have it in the back of my mind that if the rates started going up rapidly, I would try to lock it in.
What interest rate did you get?
Prime – 0.85%, which is 2.15%.
Were you happy with your interest rate at the time?
Are you still happy with your interest rate now?
Yes. Prime rate has been 3.00% since before I took out my mortgage, so my variable rate of Prime – 0.85% has left me with an interest rate of 2.15% for the entire term.
Why did you choose a 5-year term?
I guess just because it is the most common, and I didn’t have a reason to need a shorter or longer term. I did, however, briefly consider getting a 10-year fixed term, because the rate being offered was fairly low at the time.
What factors influenced your decision?
As I mentioned, I have disposable income in my budget that I could use if interest rates (and, therefore, my mortgage payments) suddenly increased. I know people usually get a fixed rate for ease of budgeting, so they know what their payment will be for the next 5 years, but I felt comfortable opting out of that stability in order to get the lower rate. Also, my income will increase at a good rate over the term of my mortgage, so as time goes on it will be even easier for me to manage a sudden increase.
Would you choose a 5-year variable term again? Why or why not?
I haven’t had any issues with it so, yes, I would. Of course, depending on how the rates are sitting when it comes time for me to renew, I may have to consider going a different route – but I’ll worry about that when the time comes.