Pros and Cons of a Shorter Term

When would you get a shorter term mortgage versus what has reliably been the standard term in the industry (the 5-year term)? There are a number of things to consider, and as with everything, there are pros and cons that you must consider before asking for that shorter term on your renewal or purchase. Before we begin, for a list of mortgage definitions including the mortgage term (not to be confused with amortization period), please see our past post found here.

 

Short term is defined in the mortgage world as anything that is less than 3 years. As you know, typically people looking for a mortgage are drawn to the standard 5-year term, which has been the industry standard for some time. However, shorter terms can be useful in some situations. Specifically when nearing the end of your mortgage and you are paying more principal, a short-term mortgage could be useful for those with short-term financial needs as an increase in the rate wouldn’t affect you as much, or if you were speculating that the fixed rate will lower soon.

The downside to this speculation is that there is increased risk. If you’re bet doesn’t pay off, you might have to renew at a higher rate, whereas if you were locked in for a 5-year term, you would still be beating the current rate.

 

Another downside to shorter terms is that to qualify for these rates, lenders typically require you to prove that you can afford to pay the posted rate to qualify. So if you don’t have the built-up equity in your house, a higher net worth and job stability, these rates would be tough to qualify for. Typically this means that a first-time home buyer would be excluded from the lower rates that shorter terms afford. Also, if you are switching from another lender to take advantage of a low short-term rate with another lender, your switching costs would more than likely have to come out-of-pocket. While lenders will typically pay for your switching costs if you were signing up for a longer term (anywhere from 3 to 10 years), for shorter terms you would have to fork over the cost on your own. This means you would have to factor in that cost based against the cost savings you are getting from the lower rate.

 

So while short-term mortgages can be used as a tool for short-term financing, for the most part, the risk associated with them is not worth the savings you would get on the rate. A typical mortgagee would be better off going with the standard, 5-year fixed mortgage that affords more stability.

 

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