Renewing Soon? Why a 1-Year Fixed Is the Priciest Way to Wait
I had Jesse Merson on the podcast. He has spent about 20 years in mortgages, most of it inside two of the big banks, and he is now a mortgage agent with Vine Group Mortgage Brokerage. I asked him about the renewal calls he is getting, and one answer stood out.
People who want to keep their options open are asking for the shortest fixed term they can get. One year. Two years. Just enough to wait out whatever is in the headlines this month.
I typically will suggest a variable, because you’re paying a premium, a significant premium, for a one year fixed.
Jesse Merson, Vine Group Mortgage Brokerage
Why is a 1-year fixed so expensive?
Because the lender is pricing in the uncertainty for you. According to Jesse, 1 and 2 year fixed rates are currently priced higher than 3, 4 and 5 year terms. You pay more for the privilege of committing for less time.
That would be fine if the short term bought you something a variable cannot. It mostly does not. The whole point of a 1-year fixed is to get out soon. A variable already lets you do that.
How fast does a variable rate pay for its penalty?
Here is the math, using the example rates Jesse gave on the show: a 5 percent 1-year fixed against a 3.7 percent variable, on a $600,000 balance. These are illustrations, not quotes. Your own rates will differ.
| 1-year fixed at 5% | Variable at 3.7% | |
|---|---|---|
| Interest in the first month | $2,500 | $1,850 |
| Monthly payment (25-year amortization) | $3,508 | $3,068 |
| Interest paid in year one | $29,719 | $21,949 |
| Cost to break early | Depends on the lender | About 3 months’ interest, ~$5,550 |
The variable saves about $650 a month in interest. Its penalty is about $5,550. So even if you break it, the variable is ahead after roughly eight to nine months. Jesse’s rule of thumb on the show was seven or eight months, and the exact figure moves with your balance and your rates. Either way, most people who pick a 1-year term are paying extra for flexibility they could have had cheaper.
The strategy Jesse uses: pay the fixed-rate payment on a variable
This was the part of the conversation I liked most, because it answers the real fear. People do not pick short fixed terms because they love fixed rates. They pick them because they are scared of a rate hike.
If you’re comfortable with a higher payment, let’s just set it up with a higher payment right away, as of day one. That extra money is paying down the principal quicker, and you’re sort of front running any potential rate hike.
Jesse Merson, Vine Group Mortgage Brokerage
Does your payment change when the rate changes, or does it stay the same? In Jesse’s experience, many big bank variables keep the payment fixed, so when rates rise, more of each payment goes to interest. Rise far enough and you hit the trigger rate, where the payment no longer covers the interest. During the pandemic Jesse saw amortizations stretch past 60 years this way. Know which kind you have.
When a fixed rate is still the right call
- If headlines will cost you sleep. Jesse was clear: if you are not interested in following rates and would worry about every Bank of Canada announcement, a fixed rate is a legitimate choice.
- Pick the term for the rate, not the calendar. If you go fixed, compare the 3, 4 and 5 year rates rather than defaulting to the shortest one.
- A split is an option. Some lenders let you put part of the mortgage in fixed and part in variable, which hedges both ways.
- A short term stacks your renewal. One or two years goes quickly, and the problem you were waiting out may still be there.
None of this is a prediction about where rates go next. Jesse does not know, I do not know, and anyone who tells you they do is guessing. The point is narrower: if what you want is room to move, there is usually a cheaper way to get it than a 1-year fixed.
Watch the Full Episode
My full conversation with Jesse Merson, including trigger rates, the renewal cliff that never came, and blanket appraisals on pre-construction, is on Supply and Demand.
Frequently Asked Questions
Is a 1-year fixed mortgage a good idea?
What is the penalty to break a variable rate mortgage?
How fast does a variable rate pay for its penalty?
Why would I choose a higher variable payment than required?
What is a trigger rate?
Related Reading
- Why Nobody in Canada Is Signing a 5-Year Mortgage Right Now
- Mortgage Renewals in Canada: What the Banks Aren’t Telling You
- How Banks Use Blended Mortgage Rates: What to Ask Before You Sign
- Why 35-Year Mortgages Are Creating Forever Loans
If your mortgage is coming up for renewal and you want a second set of eyes on the options, send me what your lender offered. I am happy to go through it with you, no obligation.