The Ten-year Fixed-rate Mortgage: A Contrarian’s Point of View

A couple of caveats before I start. Most mortgage industry people do not like the ten-year product. They will say that the rates are higher, that the payout penalty is too high and that, based on historical data, choosing the ten-year fixed has cost you more in interest payments the vast majority of the time. That said, past results are not necessarily an indicator of future performance, and I think any conservative borrower who wants interest rate protection should give the ten-year fixed-rate mortgage a long look. Here’s why:

If it’s interest rate protection you seek, a five-year mortgage doesn’t actually give you much. While most experts would agree that we are at or very near the bottom of the current interest rate cycle, this only tells half the story. What we’d really like to know is when rates will start to rise. Assume, for example, that rates start going up three years from now. Taking a five-year mortgage today would give you two years of “real” protection before you were forced to renew your mortgage rate in a rising rate environment. In that scenario, the premium you pay for the protection you get isn’t worth it.

With a ten-year fixed product, the timing of when rates will rise becomes less of an issue. If you believe that we are near the bottom of the interest rate cycle and if you expect rates to rise at some point in the future, then locking in your rate for the longest possible period makes the most sense. Using the scenario above, if rates start to rise after three years you still enjoy seven years of protection. When we add in the fact that the premium you pay today for a ten-year term is at or near its all-time low, the ten-year starts to look attractive. To put today’s ten-year rate into further perspective, consider that right now it costs you around 3.64%, which is much lower than the average five-year fixed rate over the past ten years (calculated by taking the Big Five bank’s average rate over the past ten years minus 150 basis points: 6.07% – 1.5% = 4.57%).

Probably the biggest knock on the ten-year fixed is the penalty you have to pay if you want to discharge early. It’s true that if you break your mortgage in the first five years your penalty will be huge, so if you think you will move or refinance in less than five years this product is not for you. What many borrowers and agents don’t know however is that after five years, the Interest Rate Act mandates that lenders may only charge a maximum prepayment penalty of three months interest. So as long as you keep your mortgage for the first five years, you are effectively getting a second five-year option that costs three months interest if you decide not to use it to the end of its term. If you think rates are going up, that’s a pretty sweet deal.

A final thought. A ten-year fixed rate can be combined with a floating rate line of credit to create a readvanceable mortgage for anyone who wants to balance short term interest cost savings with long term rate protection. In fact, when I bought my first house in 2003 I chose a readvanceable mortgage with a ten-year fixed term at 5.35%. In retrospect, other products would have resulted in lower interest payments, but if disaster had struck I was well protected. I don’t regret paying more for some extra insurance I didn’t end up needing.