Soaring interest rates often cause consumers to rethink their mortgage strategy. While it may be tempting to invest in a shorter term with the anticipation of lower interest rates in the future, there is some risk associated with this behaviour.
In this article, we will explore the shifting thoughts behind fixed-rate mortgages in Ontario and examine whether they are beneficial.
When are short-term mortgages beneficial?
If you anticipate interest rates to drop, then investing in a short-term fixed mortgage may be advantageous. It allows homeowners the stability of fixed rates knowing they will not have to pay more in interest if the prime rate increases.
Shorter terms mean that homeowners don’t have to pay the higher interest rates associated with longer terms. Furthermore, they can take advantage of lower interest rates sooner. However, this hinges on knowledge of the interest rate dropping soon.
When does this become a gamble?
Historically, shorter term mortgages have been beneficial to homeowners and lenders. For a lender, there is adequate revenue forecasted to provide deeper discounts to their profit margin. This means that shorter terms are mutually beneficial. Shorter term rates become lower priced when compared to five-year rates, allowing lenders to assess risk contrasted with costs.
However, when inflation surges, there is more risk involved.
While homeowners may rush to invest in one-, two-, or three-year mortgages, there may be a downside to this line of thinking. The excitement behind this move involves the profound belief that interest rates will drop. This means that people firmly believe the Bank of Canada is effectively fighting inflation.
Rising inflation means increased rates, as economic uncertainty places pressure on individuals as they wrestle with higher costs.
While investing in a shorter term may look good on paper compared to five-year terms, homeowners may be paying higher interest rates when contrasted to previous years.
To further complicate things, homeowners must know that interest rates will drop within the selected time frame. This tactic is what makes it a gamble.
Why are shorter terms becoming a trend?
Shorter terms are trending because they provide a better solution for rising inflation costs. Homeowners don’t want to invest in variable rates because of interest fluctuations. Fixed rates offer predictability in monthly payments, making them more appealing. They allow homeowners to delay locking in higher interest rates for longer terms.
Since economists predict high interest will shortly decrease, there is a belief that the payoff is greater by delaying locking into a higher long-term rate. It ends up saving them money in the short term until they can obtain a better interest rate, thereby lowering their costs.
Short-term fixed-term mortgages in Ontario become beneficial when looking to maintain cash flow. It is helpful if you are unsure of your employment situation or may be anticipating a decrease in income. It is also beneficial if you anticipate relocation due to employment or changing communities due to aging parents.