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January 28, 2010

I wanted to share with you the email I sent to Rob Carrick in response to his article in the Globe and Mail this morning.


I hope all is well. I read your article with great interest this morning – I actually enjoy all of them. It is important that Canadian’s understand the problem with a ten year mortgage and how one can protect themselves with another strategy and be better off.

First off, the ten year term mortgage is a significant money maker for the bank and the mortgage professional but a sucker play for the Canadian homeowner. A ten year term solidifies a very large yield for the bank for a long period of time and compensates the mortgage professional almost double that of a five year term. The client, on the other hand, pays a large premium and is not further ahead. However, there is a strategy that would yield a better outcome and still provide peace of mind.

Let me explain using a $100,000 mortgage with a 25 year amortization:

The ten year term at 5.30% results in a monthly payment of $598.80 and after the five year mark, the balance will be $88,919.23. After the ten year term is expired, the balance will be $74,525.95. This is provided all monthly payments are made on time. These are two very important milestones to keep in mind.

A more beneficial strategy would be to opt for the five year term at 3.79% and make your monthly payment based on the $598.80 ten year term rate –instead of paying the bank a premium for the additional 5 years, you will be paying yourself – the mortgage. At the five year mark, you will owe $81,190.57 which is $7,728.66 less than what you would owe with the ten year option. But what happens after five years? Where will rates go?

This is a good question. Let’s assume rates will increase to 6.78% which is the average rate for the past decade as noted in your article. Owing $81,190.57 at this point, your payment increases by $15.47 per month resulting in additional payments totaling $928.20 for the last five years at the higher rate of 6.78%. Fortunately for the borrower, the balance at the end of the term would be $69,693.98. Calculating the payment increase, NOT TAKING the ten year term will save the borrower $3,903.77 in after tax income.

In my opinion, I don’t see the five year increasing over 3.00% in the next five years so this assumption is quite safe. The key to borrowing is that one needs to minimize the interest rate at the beginning of the amortization cycle – it is the point you owe the most money. The opportunity to pay down as much of the balance early can mitigate higher rates down the road because you owe less. For example, if one pays 5% when they owe $100,000 the interest cost is $5,000. If they pay the debt down to $50,000 and the interest rate increases to 10%, the interest cost is $5,000.

We need to educate Canadian’s to pay down debt and not worry about interest rates and long term security and peace of mind. A higher interest rate (5.30% for ten years) prohibits a borrower to accelerate the payment of their mortgage – the focus should be on paying down debt.

A message to all those taking a ten year term: There is a reason why the banks have a big smile on their face as they escort you out of their office.

Take care,

Vince Gaetano, AMP
Principal Broker/Vice President