Why do different terms have different rates?

Here's how it all works to provide you with (mortgage) choices.

A tightly-wound system of financial rules and influencers determine what mortgage terms are offered, and at what rate — including wiggle room for lender competition.


The inner workings of terms (to understand the whole 'rate' machine).

Looking at rates online, you may be wondering what goes into where each term rate is set. That's because, in choosing your mortgage term, you're likely considering both the current rate AND where rates may be at the end of your term (renewal time) when deciding how long to lock in your rate.

Overall, the economic setpoints, term length, rate type (fixed vs variable), and lender deals and discounts all factor into why different terms have different rates.

But, like all things rates, it's not a straightforward mechanism. Here's a helpful walk-through to better understand how mortgage-term rates function.

Mortgage Term Basics

  • A Term Is: A shorter contracted length of time during your full mortgage amortization that you agree to pay the lender a set rate together with amounts going to your mortgage principal (your mortgage payment).
  • Funding Costs: Lenders want to cover their costs (and risk factors) during a term, which is why some terms are offered at higher rates than others.
  • Fixed Rates: Set rate and payments; more fixed-rate terms are offered, from 6 months up to 10 years.
  • Variable Rates: Floating rate and payments; usually offered for 5-year terms (though 1 and 3-year exist).
  • Economic Setpoints: Fixed-term rates are set to echo the same term lengths of government bond yields and are usually set higher than yields. Variable-term rates are based on lender prime rates guided by the Bank of Canada policy rate.
  • Deals and Discounts lenders offer to attract your mortgage dollars can make some term rates more competitive in response to market activity.

How are rates set for different mortgage terms?

Fixed-Rate Terms

Fixed mortgage rates come in several term-lengths — set by the light of term bond yields in the government bond market.

MORTGAGE RATES for fixed terms are set according to Canadian government bond yields of that same term. (You can watch bond yields to see where fixed mortgage rates may be going.)

  • Fixed rates for a specific term are typically set higher than their bond-yield term counterpart — because mortgages are higher-cost to operate (and lenders need to cover their costs).
  • So, the 'best' 2-year mortgage rates are informed by where the 2-year government bond yield sits, and so on, by a spread relationship of about 1-2%.
  • The 5-year bond yield is used as the baseline (the most commonly bought and sold term length) and controls the market for where other terms are set.
  • However, each term length can still experience slight upward or downward fluctuations independent of other terms due to different market pressures.
  • Lender deals and discounts for certain terms help them compete in response to consumer demand.

Variable-Rate Terms

Variable mortgage rates are typically offered in 5-year terms — and are set according to bank prime rates, led by the BoC's policy rate.

MORTGAGE RATES for variable terms aren't 'fixed' and float with changes in the prime rate, so lenders prefer to offer this rate type for a longer term length (5 years).

  • A variable rate term is more about the 'long game' of seeing rates average out to savings over the term (or life) of the mortgage loan.
  • Floating nature of this rate type increases a lender's cost to manage; a 5-year term offers an industry standard for funding efficiency (shorter variable terms cost more).
  • For borrowers, a 5-year term (vs. 1 or 3 years) also allows more time for any rate changes to (hopefully) average out in their favour.
  • Rarely, a lender may lose confidence in the BoC's rate point and can independently set its prime rate.
  • Lenders offer discounts off their prime rate to compete for client mortgage dollars (depending on application strength).
  • Variable terms longer than 5 years aren't offered, as a lender wants the opportunity to reset its rate discount.

What mortgage terms do lenders offer?

Fixed-rate mortgage terms typically available: 6 months, 1, 2, 3, 4, 5, 7, or 10 years (with 5 years being the most commonly chosen).

Variable-rate mortgage terms typically available: 1 and 3 years (rarely); 5 years is the industry standard.

Some lenders (such as MFCs) may offer only the more 'popular' terms if they look to increase cost-efficiencies to lower mortgage rates for clients.

Did you know? Your current mortgage term rate and options may be portable. If you think you'll need to move but are currently locked into a longer term, this feature may help you 'port' your mortgage over to a new home during your term to save on interest and penalties. Read more here.

Shorter and longer-term rate trends:

Why are variable rates usually lower than fixed rates?

A 5-year variable rate is typically LOWER than a 5-year fixed rate because it carries more risk for change and appeals to fewer home buyers and owners — capitalism reigns here.

Not every Canadian applying for a mortgage can handle the budget stress of changing payments, so a variable rate is typically lower to attract those willing and able to put up with possible budget mayhem to (hopefully) save more. (Historically, variable rates tend to outperform fixed rates — over the long term.)

But like all things 'rates,' nothing is set in stone. With recent market upheaval caused by the fastest-ever rate tightening cycle by the Bank of Canada, variable rates (advertised with lender discounts) have recently seen periods of inversion, where some terms with fixed rates have been lower.

Are short-term fixed rates cheaper than longer terms?

Mortgage rates for terms less than 5 years are typically LOWER than those for 5 years or longer (for closed mortgages) because you're borrowing money for less time.

A shorter term carries less risk for the lender that you'll default, and if rates go up, you'll have that lower rate for less time (but it raises your risk if you have to renew into a higher rate). The longer out you go, the more the rate can have a 'premium' attached — you're paying for the privilege of borrowing for a longer period, and banks need to ensure they'll cover their funding costs.

But, this relationship can flip, depending on market conditions. In that case, choosing a shorter term, even though it may be at a higher rate, can still offer a savings strategy based on anticipating where rates may be headed.

Why are 5-year terms more popular if they usually come with higher rates?

Again, capitalism reigns because most homeowners prefer to lock into a standard 5-year term to settle into their budget, lessen the risk of being exposed to rate changes, and reduce the time involved in renewing more often.

So lenders are still very competitive on 5-year rates because this length of time also helps reduce their costs to manage the mortgage. If everyone switched to only wanting 2 or 3-year terms, then you'd likely see those rates switch to being typically higher, regardless of where the bond market or policy rate sits.

Can surfing from short-term to short-term fixed rates for the life of your mortgage loan (vs longer 5-year terms or even variable-rate terms) save you more money in the long run? Read about it here.

Why might your actual mortgage rate be higher than advertised for a certain term?

The lowest advertised rates you see are typically for clients with strong application factors, like very good credit, lower debt-to-income ratios, and solid income history.

These factors, plus whether it's an insured versus uninsured mortgage based on the size of the down payment, can combine to provide a mortgage application that is considered less risky by lenders. If everything lines up well, these clients are often able to secure lower interest rates (though all mortgage applicants still need to qualify for their rate through the federal stress test).

Need some helpful advice to get a better rate? At True North Mortgage, we focus on getting your best rate for your situation. Plus, our in-house lender, THINK Financial, has rates that are 0.20% lower on average compared to the competition.

We can also help with strategies to lower your mortgage rate or find other ways to save over the life of your mortgage.

The rate-machine whisperer? That's us.

We exist to simplify your mortgage term and rate choices, outlining the details to help you make clearer decisions to reach your (mortgage) goals.

We really know mortgages — it's all we do, and we're neck-deep in all the market trends. Our high volume not only allows us to pass along a rate discount to lower your rate on the term that best suits your situation, but we have the insights to help you form the best mortgage strategy to save more.

Plus, we make your mortgage process simple to get your approval done right, and on time.

Where are you in Canada? Our brokers are available nationwide — online, over the phone, through Morgan our mortgage chatbot, or at a store near you.

Get a mortgage on your best (rate) terms.