Mortgage Jake

Examining the 10-year fixed option.

A first-time buyer posed an excellent question for me this week about the new 10-year fixed vs the current 5-year fixed terms, and wondered what would the rate have to be in 5 years to make-or-break their decision. The answer; 4.35% thereabouts. The formula is simple. Run a mortgage amortization calculation for a hypothetical amount (in my case, I did $400K at 3.29%, 25-year amortization with semi-annual compound interest and monthly payments).

Here’s the math:

5yr fixed, $400K loan, 3.29% rate.
end balance is $343782

10yr fixed 3.89%
end balance is $283942

So what rate must you get better-than in order to achieve the same end balance upon your 5 year renewal?

Answer: 4.35% or better.

Reason: $343 782 maturity in 5 years
20 years amortization left
at 4.35% with that rate and term, 60 months later your end balance is $283 307 or a $600 difference.

The question is: where will rates head in the next 5 years? If you’re a betting man I’d bet on OVER for 4.35%. Traditionally 6.2% is an average 5-year rate. However we’ve been through some pretty rough patches lately economically so that average has gone down.  Take a look at this chart:

http://www.canequity.com/mortgage_rate_history.stm

It’s an amazing 10yr chart showing the average 5-year rates. Having worked in the past 9 of the 10 years I certainly recall 7%+ commitments, and I remember when 4.35% was SUCH an amazingly low rate that people were jumping out of cars to take it.

Some things to consider about the 10-year option:

In Canada the penalty to break any 10-year term works like this: first 5 years is subject to I.R.D, or 90-days interest, whichever is greater, and the next 5 years is 90-days interest penalty only. These mortgages are of course portable and assumable meaning you may transfer them to another property OR “sell” them to a new qualified buyer and avoid the penalty. Furthermore, ING is very fair in their I.R.D. calculation (as opposed to the big 5), as they use discounted-to-discounted rates when comparing, vs discounted-to-posted rates. The difference can mean thousands in savings.

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