Refinancing with a short term or long term rate

In a market with all time low rates some home owners are wondering if they should considering refinancing with a short term or long term rate.

The banks typically promote the 5 year term and many home owners think this is the only option for mortgage financing.  If the bank’s 5 year fixed rate isn’t competitive they offer a 4 year rate instead and only when you go to sign do you realize you have a 4 year term.  I try to stay away from interest rate wars and guide my clients through a conversation.  What are you planning to do over the next 3-5-10 years? Maybe you want to move, renovate, start a family, invest in more real estate.  Only when we have an idea of what you see for yourself over the next few years can I advise you on the mortgage terms that will fit your needs and the corresponding rate.   Then you can decide whether refinancing with a short term or long term rate is the best option for you.

I talk with clients about the reason they are refinancing in the first place, the costs of refinancing (penalty on ending their existing mortgage term) and only if the numbers make sense we move ahead to refinance the mortgage.  Then we discuss a short term rate of 1-3 years versus a longer term rate.  For people near the end of their mortgage or those with rental properties the shorter term may be the best option.  For some people the 10 year term is a great fit if they need to know their costs for a longer period of time.  I always run the numbers to ensure they can see their overall costs over the term of their mortgage and know the risks and rewards of their choice.
 A client recently chose to go with the 5 year term saving over $3,000 in interest and shaving 4 years off their mortgage.   We chose this option after asking “What happens in 5 years when rates are higher? ”  It is a fair question.  Fixed rates would have to go up by approximately 2% to offset the gains with the lower rate on the shorter term.  There is a chance the 5 year fixed rate could rise by 2% over the next 5 years.  In their case once they set a plan to increase their existing payments by 10% they were reduced their principal over the 5 year term.  Rather than paying higher interest over 10 years they would take advantage of the lower 5 year rate and put the difference (3.89%-2.94% to pay down principal).  They were comfortable with this strategy to offset any increase in rates when they renew their mortgage in 5 years.  Again, depending on your personal situation and plans moving forward – either term could be a good solution for you.  Discuss your options with your mortgage broker so you know what you need before you start getting caught up in the rate race.