Recently the Canada Mortgage Trends blog had a post discussing the current economic environment with the author of one of the most influential studies on fixed and variable rate mortgages, Dr. Moshe Milevsky. He brings up some interesting points such as how you can calculate the breakeven interest rate for deciding between different types of mortgages (where’s the online calculator for this?). It seems that variable rates may no longer have the same advantage that they did in recent history, something I’ve started to suspect.

One of the things that jumps out at me is the discussion of short terms – even going as far as calling a 5-year term “long”. With the number of people who can’t renew their mortgages at the end of the term now, and the probability that interest rates can’t stay this low forever, I would hardly think of 5 years as a long term.

I recently read The Subprime Solution by Robert Shiller, which discusses some of the things done after the great depression. One of the surprising facts is that at the time many people had short terms for their mortgages, with less regard for matching the term to the amortization (apparently many people weren’t that concerned about when it would be paid off). With the increasing length of amortizations now this is sounding very familiar.

During the depression the US government created a new institution that gave lenders incentives to use longer terms and match them to the amortization instead of renewing and refinancing constantly. Many people seem to think this is the new way to finance houses, but if it’s caused problems before it may not be that great. I’ve been thinking that way myself – I don’t have much of a preference for a term greater than 7-10 years and will strongly consider a 5-year term if the rate is lower, but I have to wonder if I would be protecting myself from future risks well enough.

A short term could have advantages if it means you can negotiate a better rate due to a change in your situation later on, or you can take advantage of it to reduce the principal before renewing. However it’s always dangerous to take a short-term loan for a long-term liability, a lesson which has apparently been learned and forgotten in the past.

As always the only real solution is to consider your needs and think for yourself.

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