Short and Long-Term Mortgages

The length of mortgage terms vary widely - from six months right up to seven, ten and now twenty-five years.  In general, the shorter the term, the lower the interest rate; the longer the term, the higher the interest rate.

While you will obviously want to choose the lowest rate possible, you'll also want to safeguard against fluctuations in interest rates.  How then do you select the best term for you?

Normally that situation is based on your personal situation, your forecast of interest rates for the future and the degree of risk which you find acceptable.  Here are some examples:

• If you plan to sell your house in the short term without buying another, you may find a short-term mortgage to be the best option.
• If you believe that interest rates have "bottomed-out" and are not likely to drop more, you may wish to lock into a long-term mortgage.  Conversely, if rates are currently high, you may opt for a shorter or medium-term mortgage in the hopes that rates will have dropped by the time your initial term expires.
• If you are a first-time buyer, you may prefer the security of a longer-term mortgage, at least early on, so that you are better able to budget for and manage your monthly expenses.

Closed, Open and Convertible Mortgages

In a closed mortgage, the interest rate is locked in for the full term of the mortgage and you must pay compensation, or breakage costs, to the mortgage lender in order to renegotiate the interest rate or pay off the balance prior to the end of the term.

Closed mortgages are usually the better choice for buyers who suspect that interest rates may be on the rise and for those who are not planning to move in the short term.  They are often considered ideal for first-time buyers, particularly in the early years.  Interest rates for closed mortgages are generally lower than for open mortgages and first-time buyers are often more secure knowing exactly how much their mortgage payments will be over a set period of time.  Closed mortgages are generally available in a full range of terms.

Open mortgages offer greater flexibility than closed mortgages since they can be repaid either in part or in full at any time without breakage costs.  Open mortgages are generally available only in terms of six months or one year.

Open mortgages can be a valuable option if you expect to come into a substantial sum of money that you can apply against the loan principal or if you know that you'll be selling your home shortly.  By completely paying off an open mortgage, you effectively terminate your contract with the lender and you're free to negotiate a new mortgage for the size, rate and term that best suit you at that moment.  The trade-off for this flexibility is that interest rates are one or two percentage points higher for open mortgages.

A convertible mortgage gives you the same security as a closed mortgage, plus the flexibility of being able to convert to a longer, closed mortgage at any time without penalty.  If you think that interest rates may drop, this allows you to wait until you feel the time is right.  If rates begin to rise, you can lock in.

Fixed-Rate and Variable-Rate Mortgages

The interest rate for a fixed-rate mortgage is locked in for the full term of the loan.  Payments are set in advance for the term, providing buyers with the security of knowing precisely how much their payments will be throughout the entire term.  Fixed-rate mortgages may be either open (may be paid off at any time without breakage costs) or closed (breakage costs apply if paid off prior to maturity).

With a variable-rate mortgage, payments are generally fixed for a term of one or two years even though interest rates may fluctuate during that time.  If interest rates go down, more of your regular payment is applied to reduce the principal; if rates go up, more of the regular payment is applied to payment of interest.  Variable-rate mortgages are generally open.

A variable-rate mortgage provides the buyer with the flexibility to take advantage of market conditions and to pay off the entire mortgage or convert to a fixed-rate mortgage at any time without breakage costs.

Amortization Periods

Amortization periods (the total period of time over which your mortgage must be repaid) also vary widely - usually 15, 20 or 25 years, or anywhere in between.

Since most people want to keep their regular mortgage payments as low as possible, many choose to amortize their mortgage over twenty-five years.  While this may be advantageous in the early years of home ownership, particularly for first time buyers, the impact of this decision over the long term will be more costly.

The total amount of interest you will pay over the life of your mortgage varies according to the length of the amortization period.  The shorter the amortization period, the more you will pay on a monthly basis, but the less you will pay in interest costs over time.  Alternatively, the longer the amortization period, the less you will pay on a monthly basis, but the more you will ultimately pay in interest costs.

Payment Frequency and Other Options

Finally, taking advantage of accelerated payment frequency and other payment options can reduce the cost of your mortgage over its lifetime.

By making "accelerated" weekly or bi-weekly payments you can save thousands of dollars in interest and take years off your amortization.  With an "accelerated" payment schedule, a little more is added to each payment resulting in the equivalent of an extra month's payment each year.

Many mortgages include a prepayment clause which allows you to reduce your mortgage principal on specific anniversary dates, without incurring breakage costs, by making a lump sum payment usually up to ten or fifteen percent of the original principal.  This option lends greater flexibility to closed mortgages.

Similarly, the option to make additional monthly payments any or every month without incurring breakage costs also allows you to reduce the cost of your mortgage significantly over time.  The entire amount of the doubled payment is applied directly against the principal on a fixed-rate mortgage.

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