When it comes to mortgages, one of the biggest decisions is whether to get a 2 year or 5 year term. Both options have their pros and cons, so it’s important to weigh them carefully based on your financial situation and goals.
The Main Differences Between 2 and 5 Year Mortgages
Here are some of the key differences between 2 and 5 year mortgage terms:
- Length of term – A 2 year mortgage has to be renewed every 2 years, while a 5 year mortgage lasts for 5 years before renewal.
- Interest rate – 5 year mortgages often come with lower interest rates, while 2 year terms usually have slightly higher rates.
- Flexibility – With a 2 year term, you have the flexibility to switch lenders and lock in a new rate every 2 years if rates drop. A 5 year term locks you in for longer.
- Penalty for breaking – 5 year mortgages come with higher penalties (3 months interest vs just 1 month for a 2 year) if you break your mortgage before the term is up.
- Payment stability – A 5 year term offers more long-term consistency in payments. A 2 year term means your payments could fluctuate more when it’s time to renew.
Pros of a 2 Year Mortgage
Here are some of the main advantages of getting a 2 year mortgage term:
- You can take advantage of declines in interest rates – With a 2 year term, you have the chance to renew your mortgage more frequently and lock into a new, lower rate if rates fall.
- More flexibility – You aren’t locked into one lender or rate for an extended period. There’s an opportunity to shop around more often.
- Lower penalties for breaking your term – If you need to move or switch lenders before your term is up, the penalty fees are lower with a 2 year mortgage.
- Good option when interest rates are unstable or declining – When rates are going down, you can renew more often at better rates with a short term.
- Allows you to qualify at current rates – Can make it easier to qualify for the mortgage initially if rates are lower over a 2 year term.
Key Takeaways – Pros of 2 Year Mortgages
- Lets you take advantage of declining interest rates more frequently
- Much more flexible overall
- Lower penalties if you need to break the term
- Good when rates are unstable or dropping
- May allow you to qualify more easily at current rates
Cons of a 2 Year Mortgage
Here are some of the potential disadvantages of a 2 year mortgage:
- Rates may be higher – Lenders often offer lower rates on 5 year terms to incentivize you to lock in longer.
- Unpredictable payments – Your payment amount can vary significantly whenever you renew your 2 year term.
- More renewals and paperwork – You have to renew more often, which means more paperwork and negotiations with lenders.
- Possibility of higher costs over time – If rates trend up over many renewals, your total interest costs could be higher in the long run.
- Risk of not qualifying at renewal – Financial circumstances could change, making it harder to qualify at renewal time.
Key Takeaways – Cons of 2 Year Mortgages
- Interest rates may be slightly higher
- Payments can fluctuate more when renewing terms
- More frequent renewals and paperwork to deal with
- Higher long-term costs if rates trend upward
- Risk of not re-qualifying when your term is up
Pros of a 5 Year Mortgage
Here are some of the key benefits of choosing a 5 year mortgage term:
- Lower interest rates – You’ll often get a discounted rate by committing to a longer 5 year term.
- Payment stability – Your payments stay consistent for 5 years since your rate is locked in longer.
- Less renewal paperwork – You only have to renew once every 5 years instead of every 2 years.
- Potentially lower costs long-term – If rates trend upward, the total interest paid over 5 years could be lower.
- Forces fiscal discipline – Locking in for 5 years ensures you can comfortably afford the set payments for that time period.
Key Takeaways – Pros of 5 Year Mortgages
- Typically get lower interest rates
- Payments remain stable and consistent for 5 years
- Avoid frequent renewals and paperwork
- Could mean lower total costs if rates rise over time
- Forces some fiscal restraint and discipline
Cons of a 5 Year Mortgage
Here are some potential drawbacks of getting a 5 year mortgage term:
- Less flexibility – You’re locked into one lender and rate for 5 years, with penalties for breaking early.
- May miss out on rate declines – You can’t renew and take advantage if rates drop significantly.
- Higher penalty fees – The penalties for breaking a 5 year term early are much steeper.
- Harder to qualify initially – You may not qualify if you can’t afford the payments for the full 5 year term.
- Risk of overpaying – If rates fall, you’ll be stuck paying a higher rate for 5 full years.
Key Takeaways – Cons of 5 Year Mortgages
- Much less flexibility being locked in for 5 years
- Could miss out on lower rates if they drop during your term
- Higher penalties if you need to break the mortgage
- Potentially harder to qualify for the longer 5 year commitment
- Risk of overpaying if rates decline significantly
Which is Better – 2 or 5 Year Mortgage Term?
So with the key pros and cons laid out, which mortgage term generally makes more sense – 2 or 5 years? Here are some factors to consider:
- Your financial situation – How confident are you that your income, job, etc. will remain stable to afford payments long-term? Opt for longer terms when finances are more predictable.
- Interest rate forecast – Are rates expected to rise, fall or remain stable? Rising rates favor longer terms, declining rates favor shorter.
- Desired flexibility – Do you want the option to switch lenders/rates freely or lock in for the long haul? Shorter terms allow for more flexibility.
- Aversion to risk – Are you risk averse to rate changes and prefer payment consistency? Longer terms provide more stability.
- Penalties – Weigh the penalty fees for breaking your term, which are higher for 5 year mortgages.
As a very general rule of thumb:
- When rates are falling, shorter 2 year terms often make sense to take advantage of declines at renewal time.
- When rates are rising, longer 5 year terms often provide lower costs over the full term.
- When rates are stable, it comes down more to personal factors like flexibility needs, risk tolerance, and financial situation.
Should I Go Variable Rate or Fixed?
In addition to term length, mortgage borrowers also have to decide whether to go with a fixed or variable interest rate. Here’s an overview:
- Fixed – Your interest rate stays the same through your whole term, meaning your payments don’t fluctuate.
- Variable – Your mortgage rate changes along with the prime interest rate. Payments rise and fall with rate changes.
Variable rate mortgages generally start out around 2% lower than fixed rates, but carry more risk of rising payments if prime rate goes up. Fixed rates have stable payments but less chance to benefit from rate drops.
Those focused on payment stability may prefer fixed rates, while those comfortable with some risk may opt for variable’s potential savings.
Key Takeaways – Fixed vs. Variable Rates
- Fixed rates mean payment stability with less risk
- Variable rates start lower but carry risk of rising payments
- Fixed best for those focused on consistent payments
- Variable better for those comfortable with some risk
How Much Mortgage Can I Afford?
When deciding between 2 and 5 year terms, it’s important to make sure you qualify for and can comfortably afford the mortgage amount needed for the term length you choose. Here are some tips for calculating your maximum affordable mortgage:
- Aim to keep housing costs below 32% of gross monthly income
- Factor in all monthly costs – mortgage, property tax, insurance, etc.
- Account for other debts and expenses in your debt-to-income ratio
- Consider future expenses like childcare costs
- Build in cushion for rising rates in case of variable mortgage
- Make a budget to see how much disposable income remains
Online mortgage affordability calculators can also provide estimates customized to where you live. Get pre-approved to confirm the monthly payment you can qualify for.
Key Takeaways – Calculating Affordable Mortgage Amount
- Keep housing costs below 32% of gross monthly income
- Factor in all ownership costs beyond just mortgage
- Account for other debts in debt-to-income ratio
- Build in cushion for potential rate hikes
- Use online mortgage calculators
- Get pre-approved to confirm monthly payment you qualify for
Tips for Getting the Best Mortgage Rates
To help you get the lowest rates and most affordable mortgage overall, here are some tips:
- Shop around with multiple lenders and brokers
- Get pre-approved to show you’re a serious buyer
- Aim for a down payment of 20% or more if possible
- Work on boosting your credit score
- Reduce other monthly debts
- Consider paying discount points to buy down the rate
- Time your purchase well – rates often dip in the colder months
- Opt for an online lender for lower overhead costs
Key Strategies to Get the Lowest Mortgage Rates
- Shop around and compare multiple lenders
- Get pre-approved
- Put down 20% or more as a down payment if you can
- Improve your credit score
- Pay down other debts
- Consider buying discount points
- Time your purchase for seasons when rates are lower
- Use an online lender
Alternatives to Consider
Beyond standard 2 and 5 year mortgages, some other options to consider include:
- 10 or 15 year mortgages – Lower rates and pay off home faster but higher payments.
- ARMs – Adjustable rate mortgages with fluctuating payments tied to an index.
- Interest-only mortgages – Only pay interest initially when payments are lower.
- 40 year mortgages – Lower payments but higher total interest costs.
Carefully weigh the pros and cons of exotic mortgage types like these, as their terms can get complicated. Sticking to basic fixed rate terms often makes the most sense for buyers looking for simplicity and stability.
Key Alternatives to Standard Mortgages
- 10 or 15 year fixed rate mortgages
- Adjustable rate mortgages (ARMs)
- Interest-only mortgages
- Extended 40 year mortgages
The Bottom Line
There’s no “right” answer for everyone when choosing between 2 and 5 year mortgage terms. Here are a few final tips:
- Consider your unique financial situation and rate forecast
- Weigh flexibility vs. stability preferences
- Understand the rate differences and trend implications
- Review the fine print for penalties and conditions
- Crunch the numbers to see total costs for different terms
- Work with a mortgage broker to explore scenarios
By taking the time to research both options and understand your own needs, you can decide whether a 2 or 5 year mortgage term makes more sense for your situation.