In a 2-year fixed rate mortgage, interest rates and monthly payments remain the same for 2 years, and borrowers begin renegotiating their mortgage near the end of the term. The interest rate on a 2-year fixed rate mortgage is set in relation to Government of Canada 2-year bond yields.
The case for the 2-year fixed rate mortgage
It’s ideal for those who want the predictable payments of a fixed product combined with a relatively short time commitment. In today’s low interest rate environment, 2-year fixed rate borrowers pay only slightly higher interest rates than they would for a 1-year term -- but their interest rates are secure for twice as long!
Borrowers who choose the 2-year fixed rate mortgage also pay significantly lower interest rates than those who pick fixed rates with longer terms (ex. 5- or 10-year terms). Basically, the 2-year fixed mortgage is a good option for borrowers that want short-term security and flexibility, like families anticipating a temporary drop in income (think maternity leave or career change).
The case against the 2-year fixed mortgage
If rates stay low, borrowers who choose a variable rate product will likely come out ahead, but borrowers locked into a 2-year fixed mortgage may get stuck with higher rates. Granted, fixed-rate borrowers can pass interest rate risk to lenders, but they’ll have to pay a premium. In either scenario, the fixed rate mortgage almost always costs more than its variable counterpart. Just take a look at our graph:
Even though fixed rate mortgages generally have higher interest rates than variable rate mortgages do, more than 60% of Canadians borrowers still choose fixed. For many households, the extra cost of fixed interest is a form of insurance against rapidly rising rates – and it’s well worth paying for.
The relatively short duration of the 2-year fixed mortgage is another drawback: if rates rise in a dramatic and sustained way, 2-year fixed rate borrowers will face interest rate shock when their term expires. Their payments will be much higher and they’ll have little time to prepare for them. Meanwhile, fixed rates for longer-dated terms, like the 5 and 10-year, will remain secure.
Of course, these are the downsides that make choosing the right mortgage so difficult: beneficial features in one scenario can be negative features in another – it depends a lot on the future interest rate environment.