Tuesday 26 February 2013

Why 10 year mortgages don't make sense

About a year ago, 10 year mortgages dipped below the 4% mark, which led many to jump towards 10 year mortgages. As mortgage agents and brokers, we get paid more for selling these mortgages, so if you are considering a 10 year mortgage, make sure your broker or mortgage banker lays all the numbers out for you so you can make an accurate decision and never just go on a 'recommendation' without getting all the facts. 

For example, let's say you are considering a 10 year fixed mortgage at 3.89% vs. a 5 year fixed at today's lowest rate of 2.84%. At the end of the first 5 years, you will already be $15,647.75 ahead with the 5 year mortgage than with the 10 year (assuming monthly payments and a 25 year amortization with no extra payments made).  Edit: Based on a mortgage amount of $300,000

The break even rate in the above situation is 5.41%. This means, for you to come out ahead with the 10 year mortgage, the 5 year fixed rate at the end of the first 5 years would have to be higher than 5.41%. If it is lower than that, then you lose. That is a pretty big gamble. If you end up breaking your mortgage at the 5 year mark (most don't even make it that far), then the 10 year mortgage just cost you over $15K PLUS your penalty to break the mortgage. 

While 5 year fixed mortgages very well may be higher in 5 years than the are now, I wouldn't expect them to start skyrocketing anytime soon. Given the state of the global economy, it is going to take years before we climb out of this mess. The situation in Europe isn't getting any better, an Europe is just taking the focus off of the United States, who are in equally in bad shape. Could 5 year fixed rates be higher than 5.41% at the end of 5 years? Anything can happen, but there is a good chance that they won't be. If they are, then there may be other attractive options open to us at that time as well. Perhaps variable rates will start looking better again (they are already improving with rates as low as prime -0.50%), or even shorter term mortgages may be an option as well. Time will tell, but a 10 year mortgage would be quite a big gamble. You 'may' win, but you would have to stay in for the full 10 years to get any benefit, and that alone is a big gamble.