Is a Short-Term Fixed-Rate Mortgage Right For You?

If you’re looking for a way to save money on your mortgage while interest rates are rising, you might be curious about whether a short-term fixed-rate mortgage could help. Especially if you currently have a variable-rate mortgage, this strategy could bring some much needed stability to your household budget while we wait and see how the inflation crisis will unfold.

While this strategy is an interesting idea in theory, it may not be the best way to go in practice. Let’s explore whether a short-term fixed-rate mortgage could be right for you.

What is a short-term fixed-rate mortgage?

While most Canadians sign up for a mortgage that needs to be renewed after five years, shorter terms are available. You can get a fixed-rate mortgage with a term of as little as one year.

Historically, lenders have offered lower rates for shorter mortgage terms because they have more certainty about how much it will cost them to lend you money. The spread between the best 5-year fixed rate and the best 1-year fixed rate has typically been 40 basis points (bps), or 0.40%.

That’s not true at this moment in time, however. Because of recent trends, short-term fixed mortgage rates are currently higher than their 5-year counterparts.

Why would I want a short-term fixed-rate mortgage?

Skyrocketing inflation is putting upward pressure on interest rates, which is making mortgages more expensive. While the best 5-year fixed mortgage rate in Canada was 2.09% this time last year, today’s best rate is more than double that at 4.69%.

With much uncertainty about what’s to come for the economy, you may want to buy some time before committing to a longer-term mortgage. A short-term mortgage could keep your rate and payment the same for a year or two, at which time you might have better information with which to make a decision.

If you believe that rates will come back down, you might not want to lock into a longer term. A short-term mortgage would afford you the opportunity to take advantage of lower interest rates when it’s time to renew.

Will I save money with a short-term fixed-rate mortgage?

The answer to this question depends on whether interest rates are likely to fall dramatically over the next year. If they do, you could potentially save money by taking a short-term fixed-rate mortgage now and committing to a better rate at the end of your term.

To estimate whether you’ll save money over the course of five years, compare the total cost of a 5-year fixed-rate mortgage with the total cost of a short-term fixed-rate mortgage, plus the estimated cost over the following years.

Let’s look at an example using Ratehub’s mortgage payment calculator. A $500,000 mortgage with a 5% down payment amortized over 25 years with today’s best 5-year fixed rate of 4.69% will require a monthly payment of $2,856 and cost $114,190 in interest over the 5-year term.

The same mortgage with today’s best 2-year fixed rate of 5.29% would require a monthly payment of $2,955 and cost $20,223 in interest over the 2-year term.

 

	Rate	Payment	Total first year payment
5-year fixed	4.69%	$2,787	$33,439
2-year fixed	5.29%	$2,955	$35,463

With a higher interest rate, a 2-year fixed-rate mortgage will require higher monthly payments than its 5-year counterpart.

Assuming your primary goal is to reduce your monthly payment, you’ll need to make up for this difference over the three years following your initial 2-year short-term mortgage. To get even a slightly lower average payment over five years, you would need to get a mortgage rate of 4.40%* or better when your short-term mortgage is up for renewal. It's important to note that there are currently no short-term fixed-rate mortgages available at anywhere near that rate available in the market, so this is not even an option for the foreseeable future.  

*The average monthly payment on a 5-year fixed-rate mortgage at 4.69% is roughly equal to that of a 2-year fixed-rate mortgage at 5.29% followed by a 3-year fixed-rate mortgage at 4.40%.