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Long term rates are back
What is a long term mortgage?
Your perception of a long term mortgage will probably depend on your age. If you are under 35, you probably think of a long term mortgage as 5 years. After all, most mortgage terms run from 6 months to 5 Years. However, if you are over 35, you probably remember (or at least have heard of) the 25 year mortgage. Prior to mid 70's, most Canadian mortgages had a 25 year term.
Why a term mortgage?
The long term was a result of the mathematical calculation of amortization period. Most people could not afford monthly payments on a mortgage unless it was amortized over a longer period (say 20-25 years). Therefore most Canadian mortgages are amortized over 25 years. It was very simple to arrange a mortgage where the payments would remain the same over 25 years, after which your mortgage would be paid off in full.
Why did the long term mortgages disappear?
Chartered banks were first allowed into the residential mortgage business in the mid 70's. In order to fund these mortgages, they would take in depositor money and invest it in mortgages. The difference between the rate they earned on the mortgage and the rate they paid on the GIC was their profit. They would match their funds so they would not get caught by rate fluctuations. Under guidelines by Canada Deposit Insurance Corporation, deposits are only insured if they have a term of 5 years or less. As such, the 5 year GIC became the longest investment that banks could offer. Hence the beginning of the 5 year mortgage. Shorter mortgages of 6 month to 4 years were introduced in the 80's as borrowers demanded more money.
What is available today?
In addition to traditional 6 month to 5 year mortgage terms, many institutions are now offering 7 Year, 10 Year and 25 Year mortgages at certain times in the market.
How can they offer longer term mortgages?
The method banks use to fund their mortgages has changed. Today's rates do not lend themselves to widespread investment in GIC's. Consumers, looking for a higher return over longer periods, have turned to mutual funds as their investment of choice. The banks, on the other hand, still see the mortgage as one of the safest forms of investment for their shareholders. As such, they have found other methods of funding mortgages. They fund them with short term deposit money (they are no longer worried about matching), they fund them with savings and chequing account deposits (on which they pay practically no interest). Or they securities them and sell the entire mortgage portfolio as part of a "mortgage backed security" package. As such, you bank may administer the mortgage but may not ultimately own it!
What do long term mortgages mean to you?
In a word, Security. The security of knowing how much your mortgage payments are going to be for now and in the future. You do not have to worry about fluctuation in interest rates. The Asian Flu? Quebec talking about separation again? It won't affect your interest rate!
The fact that your mortgage is locked for a long term period gives you a chance to do some planning for your financial future. What if rates drop over the next 10 to 25 years? (Can they go much lower than they are right now?) Long term mortgages carry the same pre-payment privileges as shorter term mortgages. Most are transferable or portable. Most lenders will allow you to get out after three years on a simple payment of three months interest. If your lender does not, all mortgages in Canada are open after 5 years on that same 3 month penalty.
The question is no longer do I go short or long. It's how long do I go?
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