Which Is Better : 3-Year vs 5-Year Mortgage Term? 

On June 5, 2024, Bank of Canada slashed interest rate by 0.25% for the first time in 4 years. It currently sits at 4.75% and homebuyers expect the rate to continue dropping over the next couple years. With this hope, some are considering a 3-year mortgage over the Canadian norm of 5-year mortgage term. If you’re one of them, this blog will help you make a decision that’s best suited for your finances and personal goals. Let’s get started! 

What is a 3-year mortgage? 

A 3-year mortgage term offers more frequent opportunities to renegotiate your mortgage. If you anticipate that rates might drop or your financial situation will be becoming better, in the next 3 years, this mortgage gives you more flexibility. 

Pros

• Flexibility: More frequent renewal periods means you can adjust to changing interest rates and personal financial circumstances.
• Potential Savings: If interest rates drop, you can potentially secure a lower rate sooner than with a longer-term mortgage.
• Shorter Commitment: A 3-year term may suit those uncertain about their long-term plans or anticipating changes, such as a move or owning a property with friends. 

Cons

• Rate Fluctuations: More frequent renewals can expose you to the risk of higher interest rates at renewal time like it did at the end of the COVID-19 pandemic. 
• Uncertainty: Less stability and predictability in your mortgage payments compared to a longer-term mortgage. 

What is a 5-year mortgage? 

If you prefer stability and balance and don’t expect your finances to change as drastically, a 5-year mortgage is a safer bet. 

Pros

• Stability: Predictable payments for a longer period can help with budgeting and long term financial planning. 
• Protection Against Rate Increases: Locking in a rate for five years can protect you from potential interest rate hikes. 
• Less Frequent Renewals: Fewer renewals mean fewer opportunities for lender fees and administrative costs and less headache dealing with negotiations. 

Cons

• Less Flexibility: If interest rates drop, you will end up paying more than you should. You always have the option to break the terms but you will have to pay a penalty and that quickly adds up. 
• Potential for Higher Rates: Typically, longer terms may come with slightly higher interest rates compared to shorter terms. 

Let’s take this example 

Let’s compare a $500,000 mortgage over a 25-year amortization period with different interest rates.

– 3-year term interest rate: 4.75%

– 5-year term interest rate: 4.75%

Total Payments Over 3 Years:

• Monthly Payment: $2,832.46
• Number of Payments: 3 years × 12 months/year = 36 payments
• Total Payments: $2,832.46 × 36 = $101,968.56
• Approximate total interest for 3 years: $39,600 
• Principal Paid: $101,968.56 – $39,600 = $62,368.56

Total Payments Over 5 Years:

• Monthly Payment: $2,832.46
• Number of Payments: 5 years × 12 months/year = 60 payments
• Total Payments: $2,832.46 × 60 = $169,947.60
• Approximate total interest for 5 years: $63,600 
• Principal Paid: $169,947.60 – $63,600 = $106,347.60 

Which one to choose? 

Your choice between a 3-year and 5-year mortgage term should depend on your financial stability, market predictions, and personal preferences for risk and flexibility.

Consider a 3-Year Term If:

• You anticipate interest rates will decrease
• You prefer more frequent opportunities to renegotiate your mortgage
• You expect changes in your financial situation or may sell your home within a few years.

Consider a 5-Year Term If:

• You value stability and predictable payments
• You want protection against potential rate increases
• You prefer fewer renewals and associated costs

I can help you find a mortgage solution that fits your financial goals and provides peace of mind. Contact me today to explore your options!