The 10-Year Mortgage – A Closer Look

Alyssa Furtado
by Alyssa Furtado April 27, 2011 / 5 Comments

The best rate will save you hundreds, but the wrong term can cost you thousands

Our friend and mortgage expert John Shearer is advising RateHub readers this week on the feasibility of the rarely elected 10-year mortgage.

Too often borrowers are concerned with getting the lowest mortgage rate, not realizing locking in to the wrong term can be significantly more expensive.

The 10-year mortgage is one product that consistently demonstrates how selecting the wrong term can cost you.

Although it does not happen often, every once in awhile, a customer will inquire about a 10-year term. Record low interest rates and the inevitability of rate increases have drawn some customers to longer terms as of late.

The 10-year mortgage allows maximum risk aversion, and the knowledge your mortgage payments will not change over the course of a decade. This kind of security comes at a price, however.

Mortgage rates are priced on the risk posed to the lender. So, simply put, the longer you lock in the security of a set interest rate, the more you will have to pay the lender.

Anecdotal evidence suggests a 10-year term has historically been offered at a typical premium of 1.25% more than the 5-year term, which is the most popular mortgage term in Canada.

You may be willing to pay a premium for future protection, but let’s look at how much that extra security will cost you in the short term and also how many times the added security has paid off in the last 25 years.

For the purpose of the following examples, let’s use a premium of 1.00% on the 10-year mortgage compared to the 5-year mortgage. This simplifies our discussion as well as provides a conservative outcome.

 (Note: A recent synopsis of lenders’ rate sheets indicate 1.00% as the average difference between 5- and 10-year terms)

Is paying the premium for a 10-year mortgage worth it? We can assess the short-term cost of opting for a 10-year term by comparing it against two consecutive 5-year terms over the same period.

Let’s say we have a 5-year fixed mortgage at 4.00% and the 10-year fixed mortgage is 5.00%. For every $100,000 of mortgage, you will pay an additional $4,788 in interest over the first five years of the 10-year term.

Assuming your first 5-year term with an interest rate of 4.00% is amortized over 25 years, the rate on your second 5-year term would need to increase by roughly 2.25% in order for the interest paid over the two terms to equal the interest outlay on the 10-year mortgage.

Make sense? Let`s look at the numbers.

  • The total interest paid over 10 years at 5.00% would be $43,588.
  • A 5-year fixed rate at 4.00% would equate to $18,615 in interest over the first five years.
  • For the 10-year term to make sense financially, a new corresponding 5-year mortgage would need to cost more than $24,973 in interest over the final five years, at a rate of around 6.25%.

So, you can see you pay a considerable premium going in to a 10-year mortgage, on the assumption interest rates will climb considerably in the near future.

How many times in the past 25 years has the 10-year rate proven more affordable than two consecutive 5-year rates? Let`s consult the Bank of Canada records.

Compiling the average 5-year fixed rates for the last 25 years from the Bank of Canada and adding a 1.00% premium, we can determine estimated 10-year interest rates. Then, we are able to conclude if the 10-year rate is higher or lower than a corresponding 5-year renewal rate.

Here’s an example:

  • In January 2000, the average rate on a 5-year fixed mortgage was 8.55%
  • We can estimate the interest rate on a 10-year mortgage in January 2000 would be 9.55%
  • If we look ahead five years, we can see what corresponding 5-year fixed renewal rate is available, and compare it to the January 2000 10-year rate
  • According to the Bank of Canada, in January 2005 the average 5-year interest rate was 6.05%

So, the interest rate premium paid on the 10-year mortgage for protection against future rate hikes not only is unnecessary, but in the example above, interest rates actually decreased over the first five years of the mortgage term.

Extrapolated over a longer period of time, we get an idea of how often the safety of the 10-year rate will pay off.

In fact, in the 300 months under review, the 10-year rate was lower than the corresponding 5-year renewal rate only eight times.

It is important to note as well that in NONE of these eight instances was the difference between rates large enough to create a positive outcome by opting for the 10-year mortgage.

While this illustration is by no means a scientific study, it does show how infrequently a 10-year rate beats two consecutive 5-year rates.

Being in a low interest rate environment, it begs the questions, is this one of the three times out of 100 that a 10-year mortgage will come out on top?

*Note that under the Interest Act you can break a 10-year mortgage with a penalty of only three months interest, after five years, as opposed to the often higher Interest Rate Differential (IRD) penalty that normally applies. However, why pay the premium in the first five years?

John Shearer
@JohnShearerIV

John Shearer is a Mortgage Agent who can be found helping first time home buyers at www.MyNewMortgage.ca and on his blog at www.OntarioMortgageDeals.com


  • Mike Webb says:

    The author is missing one crucial point – prepayments!

    I have a 10 year term and I am coming up on the 6th anniversary of my mortgage. I have been making prepayments each year and intend to pay off my mortgage this year. By choosing a 10 year term I gained the stability I wanted while also having the option to make prepayments once per year to an amount of 10% of my original principal. I have taken advantage of this option each year.

    By agreeing to a term in excess of 5 years I can also take advantage of the Interest Act which prevents my lender (a Bank) from charging me the IRD and now I am only facing a three month interest charge as a penalty for paying off my mortgage early. In the end, I will save money because I took advantage of the options available to me and the original interest rate I had to accept on my 10 year term has become increasingly less of an issue.

    • John Shearer says:

      Hi Mike,

      Your are correct that prepayments are a important aspect. A true study would have the first five year rate be paid at the same rate as the 10 year rate which would be a more balanced study. Canadian Mortgage Trends has a study like this if you are interested

      As for your own scenario statistics show that if you had obtained a typical 10 year rate 6 years ago then you could have been further ahead by making prepayments on a 5 year rate instead. As you knew you would be paying your mortgage off in 6 years you could have renewed into an ultra low 1 year term or a variable rate. The aggregate rate of these two rates versus your 10 year rate from 6 years ago would have been lower undoubtedly.

      Also the 10% prepayment is one of the lowest offered by any major lender with 15%-20% being the norm. By having opted for the lower 5 year rate then you would have been able to increase your prepayments as you would have saved several thousand dollars more in interest each year.

      That being said you found a mortgage scenario that worked for you and fit your budget and that is the goal of any mortgage professional so congratulations on being mortgage free this year!

  • Elliot says:

    I have been struggling with this decision too, but a few factors for me that makes me lean towards a 10-year.

    1. Interest rates are incredibly low, and it is hard to believe a 10-year term at under 4% will ever be seen again (to be fair, we’ve been saying that for a while).

    2. If rates were to go up 2% after 5-years, sure you may still come out ahead by choosing a shorter term, but can you afford the higher payments?

    • Jason Debly says:

      The other advantage of the 10yr fixed is that you avoid the costs associated with shorter term fixed mortgages. The costs I am talking about are transfer tax and discharge fees charged by the lender.

      For example, say I elect for a 2 or 3 yr fixed term, when that expires I am stuck paying the above fees, as I jump into say another short term fixed mortgage as I try to cherry pick the lowest rates. These costs are unavoidable and add up.

      Meanwhile if you lock in a 10yr fixed rate of 3.84% and compare that to the 2.99%, the actual difference in interest costs less the aforementioned expenses makes the 10yr very attractive for some.

      A good exercise for anyone in the market for a mortgage is to look at your remaining balance after a 10yr fixed and then compare it to the remaining balance you think you will have after two 5 yr fixed terms. You may be surprised at how little the difference is.

      P.S. I am not in the business of selling mortgages. Just my humble opinion.

  • Tim Saunders says:

    I agree with the overall take of this post as long as the consumer intends to have a mortgage for several years . I also read this post some months ago that has some great background data re 10 year terms. http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2012/03/fixed-mortgages-nickel-or-dime.html