Mortgage Term Preferences. How long is long?
Early in my commercial mortgage career, working for a major Life Insurance Company lender in the Toronto market in the early 1980’s, interest rate levels were sky high.
In an effort to curb inflation, which was threatening to spiral out of control, the Bank of Canada was regularly raising interest rates. Five year fixed term residential mortgage rates never dropped below double digit levels from the early 1970’s to the early 1990’s.
I recall meeting with the CFO of a media company, for whom I was underwriting a commercial mortgage application. Overwhelmingly our commercial loan business was written for 5 year terms at that time. Yet there was constant market anxiety on the part of borrowers, as to the potential for further rate increases. This particular individual was seeking certainty, and was undoubtedly trying to mitigate risk, in what were clearly turbulent times. He elected to lock in at 18.25% for a 20 year term loan!
Since that time, I have always been very curious as to what motivations lead to decisions on mortgage term selections. From my experience the following generally held to be true:
-Shorter terms, generally under 5 years, made sense for buyers of investment real estate who had purchased with the intent to create value during the term. A shorter term loan didn’t lock them in to a situation where they may have had to negotiate a prepayment penalty, or arrange for a loan assumption, upon property sale.
The ability to create value with a property, perhaps by improving leasing characteristics and income, also often meant that borrowers wanted to recoup some of this enhanced value by releasing additional equity. This was most readily achieved by either dealing with the existing lender, or refinancing with another, upon loan maturity.
-Mid-term length loans, typically 5 years in length, generally appealed to borrowers with no immediate desire to sell. This was usually the result of having longer term leases with little or no upside in rents. Consequently only nominal value appreciation was expected. The mid-term mortgage selection also often corresponded to the length of term of many commercial leases.
-Longer term mortgages, typically 10 years or more, were less common. It is tempting to lock in for an extended period of time. Particularly today in our extended period of historically low rates. However few investors knew with full certainty what their plans might be for a property that far down the road. As well, locking in for 10 years would perhaps only have made sense then, and now, if there were reason to think that significant rate increases were inevitable over the mid-term. An interesting thought to ponder, but less likely during these generally disinflationary times.
Keep in mind as well, that few of us are seeking long term deposit instruments at today’s low rates. Your local lender is perhaps, as a result, less interested in providing longer term money. Funds at those terms may be less prevalent.