The Pros and Cons of a Short-Term Mortgage Renewal:
Is it Worth It?

If you’re one of the 3.4 million Canadians set to renew your mortgage next year, it’s understandable if you’re feeling a bit on edge.

Your current rate was probably locked in before the Bank of Canada started raising rates in 2022. While they’ve begun to drop them again, the pace is frustratingly slow. So, you might be staring down the barrel of a higher renewal rate than you’d hoped for.

This makes it more important than ever to grasp your renewal options. The days of ultra-low rates are behind us, but with the economy shifting so quickly, it’s hard to predict when—or if—the Bank of Canada will ease up.

A short-term mortgage renewal, say every three years instead of the usual five, might help you navigate this uncertainty. But is this strategy the right move for you?

In this article, we’ll break down the pros and cons of opting for a short-term renewal. We’ll help you make a confident decision by exploring how this choice could affect your monthly payments, long-term savings, and financial flexibility in the years ahead.

Short-Term Mortgage Renewals vs. Long-Term Renewals

In Canada, a short-term mortgage is considered five years or less. But for this article, we'll define 'short-term renewals' as having terms of just one to three years. We'll call any mortgage with a term length of more than three years a 'long-term mortgage renewal.' Your mortgage term is simply how frequently you renew your mortgage, not to be confused with amortization, which is the total time to repay your loan. You have multiple terms within your overall mortgage amortization.

Understanding Short-Term and Long-Term Mortgages

• Short-term mortgage: Under three-year term
• Long-term mortgage: Over three-year term

When choosing a mortgage term, it's important to consider more than just the interest rate. A longer-term offers stability with predictable payments and protection against potential rate hikes, but it may come with higher rates and less flexibility.

The key is to find a balance that fits your overall financial strategy and future plans, like moving, refinancing, or handling changes in your finances. The best mortgage term isn't just about the lowest rate—it's about finding the right mix of stability, flexibility, and cost-effectiveness for your unique situation.

Short-Term Mortgages

In Canada, short-term mortgages typically have terms of 1 to 3 years. These mortgages are offered by both major banks and alternative lenders, with alternative lenders often providing more competitive rates for shorter terms.

In today’s landscape, interest rates for short-term mortgages can range from 4.5% to 6%, depending on market conditions and the borrower's financial profile.

Let's break down a hypothetical $300,000 mortgage renewal with a 25-year amortization on a 2-year term at 4.84%:

• Monthly payment: $1,718
• Total paid over 2 years: $41,222
• Principal paid: $13,060
• Interest paid: $28,162

Longer-Term Mortgages

Longer-term mortgages in Canada typically have terms of 5 years or more, with 5-year terms being the most common. These are widely available from major banks, credit unions, and many alternative lenders.

Interest rates for longer-term mortgages are generally higher than short-term rates, typically ranging from 4.5% to 7%, depending on the term length and market conditions.

As another example, Let's break down the same $300,000 mortgage on a 5-year term at 4.59%:

• Monthly payment: $1,675
• Total paid over 5 years: $100,528
• Principal paid: $36,220
• Interest paid: $64,308

Pros of a Short-Term Mortgage Renewal

Short-term mortgage renewals offer several advantages for homeowners in Canada. These benefits include the ability to adapt quickly to changing interest rates, potentially reduce mortgage breaking penalties, and opportunities for improved terms in the future. Let's explore these key points in more detail.

#1 More Reactive To Interest Rates

As inflation slows down, the Bank of Canada is expected to slowly lower interest rates over the next couple of years. Opting for a short-term mortgage might be a smart move right now because you'll renew into lower rates faster. If you closely follow economic trends and are comfortable with some uncertainty if it means more financial flexibility, this short-term strategy may be ideal for you.

Which sounds like the better deal - a two-year mortgage at 4.5% or a five-year mortgage at 4.75%? The two year option, of course: it saves you money immediately and lets you renegotiate for a potentially lower rate in just two years rather than five.

On the other hand, committing to a longer-term mortgage can result in you paying more than you need to if rates continue to drop. Even a small drop in the rate on a $500,000 mortgage could lead to thousands of dollars in savings a year.

#2 Potentially Reduced Mortgage-Breaking Penalties

Short-term mortgages in Canada can reduce mortgage-breaking penalties compared to long-term mortgages. You'll have more frequent renewal opportunities to make changes rather than need to break the mortgage contract and incur fees. This is because you can negotiate new terms, switch lenders, or make other adjustments at each renewal point without breaking the existing contract.

In contrast, you'll have to wait longer with a 5-year mortgage to avoid mortgage-breaking penalties. While the penalties change with fixed vs. variable-rate mortgages, they can be substantial, sometimes amounting to thousands of dollars.

If you anticipate changing your mortgage soon, opting for a shorter-term mortgage can provide more flexibility and potentially lower costs.

#3 Can Lead To Better Future Terms

If you expect your financial situation to improve soon, a short-term mortgage renewal could be a smart strategic move. Here’s why:

• Better Renewal Options: If a promotion or job change significantly boosts your income in the near future, a short-term mortgage lets you take advantage of your higher income faster. When renewing, you'll have a stronger income and can secure a better rate.
• Higher Credit Score: If you’re actively working on raising your credit score, a 2-year term could let you access better rates once your score improves.
• Improved Debt-to-Income Ratio: If you’re aggressively paying down other debts, a shorter mortgage term lets you refinance with a more favourable debt-to-income ratio in the near future. Financial experts will generally agree on the fact that you should refinance if you can reduce your interest rate by 2%.

Choosing a short-term mortgage term is ideal for young professionals on a clear career advancement track, those completing debt consolidation programs, business owners expecting significant revenue growth, and anyone with a concrete plan for financial improvement within one to three years.

If you expect positive financial improvements in the near future, opting for a five-year term could mean paying a higher interest rate for longer than necessary and missing out on potential savings from refinancing with improved financials. You might need to break your mortgage early, incurring penalties to access better terms.

By choosing a short-term renewal in this situation, you position yourself to capitalize on your improving financial status, potentially saving thousands in interest over the life of your mortgage.

Cons of a Short-Term Mortgage Renewal

While short-term mortgage renewals offer several advantages, they also come with potential drawbacks that you should carefully consider. These cons include increased sensitivity to interest rate hikes, more frequent renewal costs, and potential challenges in long-term financial planning.

Let's examine these key points in more detail to help you make an informed decision about your mortgage renewal strategy.

#1 Sensitive To Rate Hikes

While short-term rates can sometimes be lower, they can also be higher than long-term rates depending on market conditions. This uncertainty can lead to increased monthly payments and financial stress for homeowners.

Here's a deeper look at this potential drawback:

• Interest Rate Volatility: Short-term rates are more susceptible to fluctuations since you renew into market rates more frequently. If there's an unexpected economic shock or a shift in monetary policy, short-term rates could spike quickly.
• Risk of Rate Increases: If you renew into a short-term mortgage and rates rise, you'll face higher rates sooner than if you had locked in a longer term. For instance, if you choose a 2-year term and rates increase by 1% over that period, you'll be renewing at a higher rate three years earlier than if you’d taken a five-year mortgage term.
• Budgeting Challenges: The potential for rate changes can make it difficult to plan your long-term finances. Your mortgage payment could increase or decrease substantially at each renewal, which could affect your long-term financial plan.
• Stress Test Considerations: When renewing with a new lender, remember that you'll need to qualify at a higher stress test rate. The stress test is a Canadian regulation requiring homebuyers to qualify for mortgages at a higher interest rate than their actual rate, typically 2% above their contract rate or 5.25%, whichever is higher. The goal is to ensure that you can still afford your mortgage payments if interest rates rise, potentially reducing the maximum mortgage amount you can qualify for.

#2 Frequent Renewal Costs

Opting for short-term mortgages means you'll go through the renewal process more often, which can lead to increased costs over the life of your mortgage. For the most part, lenders won’t charge you fees for a renewal, but if you renew and switch lenders, there are several costs to consider:

Cumulative Closing Costs: Each time you renew and switch lenders, you may incur various fees, such as:

• Legal fees: Typically $500-$800 for a straightforward renewal with a new lender, but can reach as high as $1,500.
• Appraisal fees: Usually $300-$500, if required.
• Title insurance: Around $100-$500, if switching lenders.
• Discharge fees: From your current lender, ranging from $350-$500.

Time Investment: More frequent renewals mean more time spent researching rates, negotiating with lenders, and completing paperwork.

Potential for Higher Overall Costs:

• 5-year mortgage strategy: Over a 25-year amortization, you'd renew 5 times.
• 3-year mortgage strategy: Over the same period, you'd renew 8-9 times.
• Example calculation: Assuming average renewal costs of $1,000 per renewal:
• 5-year strategy: 5 renewals x $1,000 = $5,000 in total renewal costs.
• 3-year strategy: 8 renewals x $1,000 = $8,000 in total renewal costs.

The $3,000 difference could potentially offset any interest savings from a lower short-term rate.

#3 Difficult To Plan

Frequent rate adjustments mean you'll need to adapt to new interest rates more often, making it challenging to predict your housing costs over the long term. If you're on a 2-year term, your mortgage payment could change significantly when it comes up for renewal.

This can be particularly stressful for families on fixed incomes. The stress of regular negotiations, staying informed about market conditions, researching competitive rates, and completing the application process more often can be time-consuming and stressful.

The uncertainty around future mortgage costs can also impact other long-term financial decisions. It might be harder to commit to long-term investments or major purchases when your largest expense is subject to change more frequently. More frequent renewals mean more opportunities for lenders to reassess your financial situation, which can be challenging if your circumstances have worsened.

Is a Short-Term Mortgage Worth It for Me?

When deciding if a short-term mortgage renewal is right for you, consider the following factors:

• Market Conditions: Consider the current and projected interest rate environment. If rates are expected to fall, a short-term mortgage may be beneficial to renew faster.
• Personal Circumstances: Evaluate your likelihood of moving, selling, or experiencing significant changes in income or credit.
• Risk Tolerance: Assess your comfort level with potential rate fluctuations and the need for more frequent renegotiations.
• Cost Analysis: Work with a mortgage expert to compare the total costs of short-term vs. long-term renewals over your expected homeownership period.

Conclusion

While short-term mortgage renewals offer flexibility and potential savings in a falling-rate environment, they also come with risks and more frequent administrative tasks. The right choice depends on your individual goals, risk tolerance, and financial situation.

Before making a decision, it's crucial to carefully evaluate your financial situation and market conditions. Consider consulting a mortgage professional who can provide personalized advice based on your circumstances. They can help you weigh the pros and cons and find the mortgage renewal strategy that best aligns with your financial goals and risk tolerance.

Remember, there's no one-size-fits-all solution when it comes to mortgage renewals. By understanding your options and seeking expert advice, you can make an informed decision that sets you up for financial success in the years to come.

FAQs

What is a short-term mortgage? - A short-term mortgage is typically a loan with a term of 1-3 years. Shorter terms allow borrowers to renew or refinance their mortgages more frequently.

Is it better to have a shorter mortgage term? - A shorter mortgage term is better when you expect interest rates to fall, plan to move soon, or anticipate improvements in your financial situation. However, it also comes with more frequent renewal costs and rate uncertainty.

Should I get a short or long-term mortgage? - Short-term mortgages offer more flexibility but less stability, while long-term mortgages provide more predictable payments but less flexibility to take advantage of falling rates.