Decade-long mortgages have always been a really bad idea for almost everyone.
One big reason: The best 10-year fixed rates have never outperformed the best five-year fixed rates over any 10-year period in modern history.
But suddenly, tenners are a lot less bad. That’s thanks to sharp new rates from lenders such as HSBC and Marathon Mortgage. (Full disclosure: Yours truly refers borrowers to these two lenders, among many others.)
The former, HSBC, just announced a dazzling 3.24 per cent 10-year fixed rate. That’s the lowest 10-year fixed rate ever advertised by a lender in Canada, according to RateSpy.com data. (Update: On Saturday morning, HSBC said on its website it sweetened its 10-year fixed offer for insured mortgages even further, to 2.94 per cent. But it later said this was not the case, citing an “IT issue,” and that the actual rate for insured mortgages was 2.99 per cent.)
The latter, Marathon Mortgage, deals only through brokers. Some of those brokers are “buying down” its 10-year rates even lower than 3.24 per cent, so long as the mortgage is default insured. (A buydown is where a broker trades their commission to offer clients a lower interest rate.)
Why 10-years are getting cheaper
“Investors want more 10-year product,” Harold Kennedy, CEO at Marathon Mortgage Corp. told The Globe and Mail. “There’s more juice [profit] in it for them."
And it’s also about a flattening yield curve. “There’s not a big difference between shorter and longer duration mortgages, in terms of what it costs us,” Barry Gollom, senior vice-president at HSBC Canada, said in an interview. “So we can pass that on to customers.”
And the Bank of Canada likes decade-long mortgages, too. Just 10 days ago, Governor Stephen Poloz issued a “call to arms” to motivate the mortgage industry to sell more long-term mortgages, to reduce financial system and borrower risk.
“The comment from the governor did get us thinking about [10-year terms] again," Mr. Gollom admitted.
Who is not suited for a 10-year rate
Historically, the answer’s been almost everyone.
Fewer than one in 50 borrowers get 10-year fixed mortgages, according to the Bank of Canada. And there’s a reason for that.
The rate premium versus a five-year fixed has long been too costly. Until recently, it likely would have taken a sustained 150- to 200-basis-point surge in five-year fixed rates for a 10-year fixed to save you more interest than two consecutive five-year terms. (One basis point is 1/100th of a percentage point.)
But that’s changed. At today’s rates, the gap between competitive conventional 10-year and five-year rates is a skimpy 30 basis points. That would require the five-year rate to be as little as 75 basis points higher in 2024 for a 10-year fixed to beat a five-year fixed.
That sort of increase is arguably unlikely given the market’s current outlook, but ask any inflation worrywart and they’ll tell you a three-quarter-point rate increase is easily within the realm of possibility.
Don’t forget the non-rate factors
With mortgages, it’s never just about interest cost. Restrictive terms in your mortgage contract can cost you way more than you save from most “rate specials.”
One way a 10-year fixed can bite you is if you break the mortgage too early. Once you make it to the five-year mark in any fixed mortgage, it’s no big deal. The maximum penalty allowed by law is just three months of interest in that case. But if you break a 10-year term before five years, the prepayment penalties with most lenders can be enormous.
For that reason, if there’s a chance you’ll break your mortgage in the first 60 months, don’t even ponder a 10-year.
And if there’s a chance you’ll move or increase the mortgage within that five-year time frame, make 100-per-cent sure that you’re dealing with a lender that:
- Publicly advertises highly competitive rates;
- Offers good portability to a new property;
- Lets you increase the mortgage without any penalty (i.e., no out-of-pocket penalties and no penalties built into their new rate).
If you follow these guidelines, you’re less likely to be overcharged if you have to borrow more before your mortgage matures.
You know those people who build bomb shelters underground in the highly unlikely event Russia and the United States go thermonuclear? Well, a 10-year has traditionally been a fallout shelter from the highly unlikely event of catastrophic inflation.
It’s essentially an insurance policy. And some people are more than happy to pay for predictability. “We call it the sleep-well-at-night mortgage," Mr. Gollom says.
Indeed, for those highly risk-averse folks who don’t want to think about their financing until 2029, now is arguably the least bad time in history to consider a decade-long mortgage.
On the other hand, “If the view is that rates are going to go down and you have the ability to weather an increase in rates, then [a 10-year fixed] probably isn’t right for you,” Mr. Gollom adds.
Either way, don’t forget you get the valuable option of escaping your lender after five years for just a three-month interest charge. That lets you take advantage of lower rates in 60 months – if we get them – by breaking the 10-year fixed early and refinancing.
10-year terms could get more popular
If the spread between 10-year and five-year rates stays this tight, we’ll see a noticeable uptick in 10-year fixed demand. Heck, even the mortgage “stress test” could drive that demand. At his firm, Mr. Kennedy says, “There’s never been a time before this, where someone could qualify at the same rate on a five-year and 10-year.”
That minimum qualifying rate, as they call it – the Bank of Canada’s five-year benchmark rate – is currently 5.34 per cent. At the moment, regardless of whether you get the lowest five-year fixed or 10-year fixed rate, you must prove to the lender you can afford a higher payment based on this 5.34 per cent rate. Until recently, it was tougher to pass the stress test in a 10-year mortgage because they had much higher rates.
Some lenders speculate that the government may eventually eliminate the new stress test on 10-year terms altogether, since the Bank of Canada is promoting long-term rates and since there’s much less rate risk on a 10-year fixed. That means borrowers would only have to prove they can afford their actual “contact” rate, not a rate that’s 200-plus basis points higher. In turn, they could get bigger mortgages.
If that ever happens, man the floodgates: Demand for decade-long mortgages could surge.