Why do different terms have different rates?

How are rates set for different mortgage terms?

Fixed-Rate Terms

Fixed mortgage rates come in several term lengths — set in light of term bond yields in the Government of Canada bond market.

MORTGAGE RATES for fixed terms are set according to 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 counterparts — mortgages are costlier to operate.
• For example, the 'best' 2-year mortgage rates are informed by where the 2-year bond yield sits, and so on, by a spread relationship of about 1-2%.
• For general rate-watching purposes, think of the 5-year bond yield as the baseline (the most commonly bought and sold term length) that sets the market for other terms.
• However, each term length can still fluctuate slightly up or down, independent of other terms, in response to different market pressures (e.g. short- and long-term yield curve relationships).
• Term rates can also fluctuate because lenders offer deals and discounts to 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 5-year term length to average out prime rate movements.

• For homeowners, a variable rate term is more about the 'long game' of hoping rates average out to savings over the term (or life) of the mortgage loan.
• The floating nature of this rate type increases a lender's cost to manage, and a 5-year term offers an industry standard for funding efficiency (i.e. shorter variable terms come with higher rates).
• Lenders offer discounts off or in addition to their prime rate to compete for client mortgage dollars (depending on application strength).
• Lenders typically don't offer variable terms longer than 5 years, as they want the opportunity to reset their rate discount or addition to prime.

A snapshot: Mortgage terms that 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.

Not all lenders offer all the term lengths. Some mortgage lenders (such as non-bank MFCs, like our in-house lender, THINK Financial) may offer only standard terms to improve cost efficiency and reduce mortgage rates for clients.

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 of change and therefore appeals to fewer home buyers and owners.

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

But like all things 'rates,' nothing is set in stone. Post-pandemic, variable rates were higher than fixed for a time, as the Bank of Canada led the fastest-ever rate-tightening cycle, causing a rate-relationship inversion.

Are short-term fixed rates cheaper than longer terms?

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

A shorter term carries less default risk for the lender. The longer out you go, the more the rate can carry a 'premium' — you're paying for the privilege of borrowing for a longer period, and banks need to cover their funding costs.

And very short terms, like 1 year, may be higher than 2- or 3-year rates, depending on market conditions that can increase lender costs to manage.

But choosing a shorter term, even at a higher rate, can help you save if you anticipate lower rates at renewal.

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

Some homeowners simply prefer a standard 5-year term because it allows them time to settle into their budget, reduces exposure to rate changes, and cuts down on the time spent renewing more often or stressing about budget changes.

Lenders are still very competitive on 5-year rates because this term length is popular and locks in a longer period of fixed returns.

If homeowners suddenly decide en masse they want only 2- or 3-year terms, you'd likely see those rates rise as lenders recalibrate their operating costs.

Why is your contract term rate higher than the advertised rate?

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 or uninsured mortgage (based on the down payment amount or home equity), can affect whether a lender sees a mortgage application as less or more risky (though all mortgage applicants still need to qualify for their rate through the federal stress test).

Stronger applications are more likely to receive the best rates, and can climb from there based on borrower details. But ideally, you'll want to get the best term rate possible for your situation, regardless of what's advertised.

Grinding out your best rate.

At True North Mortgage, we put you first, not the lender, offering strategies and advice for your best mortgage solution.

Plus, our in-house lender, THINK Financial, has rates that are 0.18% lower on average compared to the competition.

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

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