Firstly, both the 5 year and 10 year fixed term rates are at or near all time lows. Historically, we’ve seen much higher rates. Does anyone remember the early ’80’s when rates were in their mid to high teens? No one would have predicted that five years earlier. I personally do not believe mortgage rates would ever come back to those levels, but what if they were to double to say 6%? Surprisingly enough, just 5 years ago to the day, our lenders were offering their best “special” 5 year fixed term rate at 5.84%. Most likely one day we will start to see a slow increase of rates so the real question is not if rates will go up, but when.
So what are we to do? There are analysts predicting our current low rates will stay this way for quite some time, perhaps a year or two or longer. Many of you are now choosing a 5 year fixed term which some lenders are now offering today as low as 2.99% (for qualified mortgages). But what if you were to consider a longer term? Some of these same lenders are also “quietly” offering (they seem to advertise their 5 year rate over the 10 year) a rate of 3.69% for their best 10 year fixed rate. What would the “break even” rate have to be in the second half of a 10 year term if you chose a 5 year rate for now instead of a 10 year rate?
Let’s look at an example:
-$300,000 mortgage amortized over 25 years on a 10 year fixed rate of 3.69%
-Monthly principal and interest payment is $1,528.05
-Balance after 10 years is $211,389.80
Same example, but now choosing a 5 year fixed rate of 2.99%
-Monthly principal and interest payment is $1,418.20
-Balance after 5 years is $256,374.38
As you can see there is a payment difference of $109.85 per month or $6,591 that you have paid less on your 5 year term than with a 10 year term. So in my next calculation I am going to increase the monthly payment for the new 5 year term by $109.85 above the payment we had for the 10 year term. Why do this? I want to show in my example that over a period of 10 years, the total payments made were the same in either situation. We also want to calculate the balance after 10 years to be the same ($211,389.80).
-New monthly principal an interest payment is $1,637.90
-Balance after 5 years (now 10 years have gone by) is $211,389.80 (same balance outstanding as shown for a 10 year term)
To compare the same with a 10 year term, the interest rate for the remaining 5 year term needs to be 4.57629% (or approx. 4.58%).
So this is the question. Do you believe that in five years time a 5 year fixed rate term will be lower than 4.58%? If so, then your decision to choose a 5 year fixed term is a good one. On the other hand, if you believe that the 5 year fixed rate term will be higher than 4.58%, you may wish to consider a 10 year term. All in all, no one has a crystal ball to accurately predict where rates will be in five years time. The choice is ultimately yours to make.
