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A person walks past multiple for-sale and sold real estate signs in Mississauga, Ont., on May 24.Nathan Denette/The Canadian Press

We’ve heard this before, but it looks like interest rates are close to peaking.

Coincidentally, so has the complexity of choosing the right term if you’re negotiating or renewing a mortgage. The cheapest mortgage rates today are for a fixed term of five years. Who wants to lock in for five years when rates are thought to be peaking?

One-year mortgages make sense because interest rates should be heading lower by then, especially if the long-anticipated recession arrives. Renewing a mortgage in 12 months lets you tap into those lower rates, but the premium you’ll pay for having that opportunity is huge. Is there a compromise between short and long?

“I find that the sweet spot is a three-year fixed-rate mortgage,” said Victor Tran, a mortgage broker with True North Mortgage and an analyst with the website RATESDOTCA. “That has definitely been by far the most popular choice for the past year now for pretty much all my clients.”

True North’s website showed a three-year fixed rate of 5.74 per cent at the beginning of this week, which is middle ground in today’s market. Its other fixed rates were 6.84 per cent for one year, 6.19 per cent for two years, 5.29 per cent for four years and 5.14 per cent for five years.

Mortgage calculator: Here's how rising interest rates affect the cost of your mortgage

A five-year variable-rate mortgage went for 6 per cent, but Mr. Tran said that option has been chosen only by a small minority of people who value the comparatively low penalty – three months of interest – for paying it off early. With fixed-rate mortgages, you pay the greater of three months of interest or a calculation called the interest rate differential (IRD), which is designed to compensate the lender for lost interest.

Variable-rate mortgages were popular during the pandemic housing boom because interest rates were ultra-low. The subsequent surge in rates has either added hundreds of dollars to monthly payments or put homeowners in a position where their amortization period has ballooned to 50 years or more. As a result, they’ll have to increase their payments upon renewal and possibly pay down their mortgage balance.

The risk in taking a variable-rate mortgage right now is that inflation is sticky enough to prompt the Bank of Canada to either raise interest rates again or leave them in place for an extended period. In any case, the variable-rate mortgage is out of favour right now with homeowners.

A one-year fixed-rate mortgage might normally be a second choice for homeowners who think rates will fall and don’t want to lock in for a long period of time. But one-year rates today are astronomically high by the standards of recent decades. If you have a conventional mortgage, where the down payment was 20 per cent or more, your rate could be around 7 per cent. Mortgages with smaller down payments must be insured against default, which allows lenders to offer slightly lower rates.

The unusual current relationship between short- and long-term mortgage rates is the result of what people in finance call an inverted yield curve. For borrowers, this means a reversal of the usual rule that borrowing for a longer term means paying a higher rate.

The five-year fixed-rate mortgage is actually the low-cost bargain right now. Locking in for five years is worth a thought for people who are confident they will remain in their homes for the full term of the mortgage and value rate certainty above all. But Mr. Tran said many homeowners are balking at longer terms such as four and five years because they don’t want to lock in for that long.

Some perspective on today’s five-year rates that makes them seem a little less bad: “I started in the mortgage industry in July, 2007,” Mr. Tran said. “I remember the first product that I sold was a five-year fixed mortgage at 5.79 per cent.” Today’s rate is well below that level.

Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.

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