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Fixed rates must take a generous tumble before a five-year fixed revival — and that’s an economic season or two away

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Not long ago, the standard issue five-year fixed was Canada’s mortgage term of choice. It sold more than any other term by a long-shot.

Then came COVID-19. Suddenly, floating rates were diving below fixed rates, and borrowers were boarding the variable train.

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That train got derailed as prime rates spiked 475 basis points in 17 months, but five-year fixed adoption has yet to return to the glory days of 2020-2021 — back when mortgage rates started with a “1.”

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Times have turned. Nowadays, fewer than one in seven mortgagors opts for a five-year fixed, according to the latest numbers from Statistics Canada. And there’s a quintet of reasons for that:

1. For most, even the lowest nationally advertised five-year fixed rates — 4.64 per cent (insured) and 4.99 per cent (uninsured) — “feel” too high to lock into long-term.

2. Economists’ forecasts and Bank of Canada guidance have borrowers concluding that rates have peaked, so folks want to ride rates down with a variable or shorter term.

3. Three-year fixed rates have become the Goldilocks of mortgages, offering protection if inflation flares back up and a shorter term for borrowers who want to reset their rate when the prime rate drops — all for not much more than a five-year term.

4. History shows that roughly four out of five times five-year fixed rates underperform variables and short-term fixed rates — depending on what backtesting assumptions are used.

5. Prepayment penalties on five-year terms are painful, and due to how penalties are calculated, they’ll increase as short-term fixed rates drop.

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Consequently, five-year fixed rates will remain unpopular for many moons.

But fivers haven’t lost all their fans. Mortgage hunters are still signing up for mortgages that mature in 2029, for three main reasons.

One is certainty. There’s no guarantee that inflation and rates will drop — and stay down — through 2029. When you’re ultraconservative, or the family budget’s tighter than a new pair of shoes, five-year fixeds provide the snug predictability many crave. And they come with Canada’s lowest rates at the moment.

The holding time frame is another factor. Most borrowers live in their homes for more than half a decade. A set-and-forget five-year mortgage therefore has appeal. As a side note, any term beyond five years entails potentially hefty prepayment penalties if you break it before the 60-month mark. By law, residential lenders cannot charge more than a three-month interest penalty after five years.

Easier approval is the third reason. Thanks to the government’s “stress test,” most borrowers must prove they can afford payments at a higher rate than their actual rate. Qualifying for a lower five-year fixed mortgage is therefore easier because the “qualifying rate” is also lower.

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So, when will five-year fixed be popular again?

Lenders would love five-year mortgages to make their grand comeback. For one thing, they’re usually more profitable. Borrowers are committed to the lender longer, the lender has more low-cost sources of five-year funding (like securitization), and prepayment penalties tend to be higher when the mortgage is broken before the contract is up.

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But for those yearning for a five-year fixed revival, patience will have to be your virtue. Fixed rates must take a generous tumble first — and that’s an economic season or two away.

Robert McLister is a mortgage strategist, interest rate analyst and editor of MortgageLogic.news. You can follow him on X at @RobMcLister.

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