Many homebuyers and homeowners find choosing between a 3-year and 5-year fixed-rate mortgage challenging. While both options can be beneficial, selecting the best mortgage solution will depend on the market outlook and your financial situation, needs, and risk tolerance. 

If you’re a homebuyer or homeowner trying to decide between a 3-year or 5-year term, this post will help you compare the pros and cons and the potential scenarios that will lead to interest cost savings on your mortgage. 

Key Takeaways

• Economic conditions, market predictions, your personal financial situation, and risk tolerance all influence which mortgage solution is right for you.
• 5-year fixed rates offer stability and predictability, while 3-year fixed rates provide more flexibility and potential for interest rate savings if rates decline. 
• A mortgage professional can provide valuable guidance when deciding between a 3-year and 5-year fixed-rate mortgage.

How to Choose Between a Fixed or Variable Rate

Fixed mortgages have an interest rate that remains unchanged throughout the mortgage term. Variable mortgages have interest rates that fluctuate based on the Bank of Canada policy rate changes. Choosing between fixed or variable will largely depend on your risk tolerance, financial stability, and whether interest rates are predicted to increase or decrease over the term. 

If interest rates are predicted to increase or you don’t have the risk tolerance or cash flow to support any potential rise in interest rates, you may choose a fixed mortgage. If interest rates increase over the term, interest cost savings can be realized by having a rate that remains the same. 

If interest rates are predicted to decrease or you have the risk tolerance and cash flow to support any market unpredictability, you may choose a variable rate. If interest rates decrease, you will realize interest cost savings over the term by having a fluctuating rate. 

Why Choose a 5-Year Fixed Rate?

Historically, 5-year fixed rates have been the most popular option among Canadians. This term provides predictable and stable payments for 5 years, meaning your mortgage payments will remain unchanged for your mortgage term. This is beneficial for budgeting purposes and can protect you from higher rates if rates increase during those 5 years. 

Many first-time buyers navigating a mortgage for the first time opt for a 5-year fixed rate since they will likely have tighter budgets than seasoned homeowners. Additionally, 5-year terms mean you won’t need to negotiate and renew as frequently, which can save time and potentially money depending on the direction of interest rates. 

Disadvantages of a 5-Year Fixed Rate Mortgage

5-year fixed rates lack flexibility and will come with penalties if you need to break your mortgage before the end of the term. These penalties could be substantial compared to shorter fixed-rate terms or variable mortgages. Additionally, If interest rates decrease during your mortgage term, you will continue to pay a higher rate, missing out on interest cost savings. 

Why Choose a 3-Year Fixed Rate?

Like 5-year fixed rates, 3-year fixed rates offer stable and predictable payments. This benefits budgeting and can protect you from higher rates if rates increase during the term. However, 3-year fixed rates have more versatility than 5-year rates, as the shorter term allows you to re-assess your goals and plans since you will renew more frequently. 

If you need to break your mortgage before the end of the term, a 3-year fixed rate will typically have lower penalties than a 5-year fixed rate. This gives you more ability to respond to life changes like selling your home to relocate or better accommodating a change in your financial situation. If interest rates decrease over your term, you can use lower rates since you renew more frequently. 

Disadvantages of a 3-Year Fixed Rate Mortgage

A shorter term means you must renew more frequently, which could expose you to higher interest rates if rates increase. You will also need to negotiate more often or switch lenders when you come up for renewal, as lenders typically don’t offer discounts on their posted rates when you renew. 

How to Choose Between a 3-Year and 5-Year Mortgage

Choosing between a 3- or 5-year fixed-rate mortgage term will ultimately depend on your personal situation, preferences, and goals. 5-year terms can provide more stability and predictability with payments. However, a 3-year term could give you greater flexibility and the potential to save on interest-carrying costs if rates continue to decrease. 

The economies in Canada and the US influence interest rates, so the short and long-term economic outlook should be considered when choosing between a 3- or 5-year term. It is recommended that you work with a mortgage professional who can help you navigate the market and analyze your financial situation and goals for a solution tailored to your needs. 

Comparing 3-Year vs 5-Year Fixed Rates

To explore how choosing a 3-year or 5-year fixed rate benefits or impacts you as a borrower, we’ll explore 3 possible scenarios to see how they affect mortgage interest costs. We are using a $400,000 mortgage with a 25-year amortization, a 5-year fixed rate of 4.34%, and a 3-year fixed rate of 4.79% as an example.  

If Rates Remain the Same

If you are presented with the above interest rates and they remain the same over 5 years, you would realize cost savings by choosing the 5-year fixed rate since it has the lower interest rate. When you come up for renewal on the 3-year term, your rate will stay at 4.79% if you select another 3-year term. Over 5 years, you would save approximately $10,780 in interest costs by choosing the 5-year term over the 3-year term. 

If you choose a 5-year term when your 3-year term comes up for renewal, your rate would become 4.34%. By this point, you would have already paid the higher interest rate for 3 years, so you would have paid approximately $6,541 more in interest-carrying costs. 

	Year 1	Year 2	Year 3	Year 4	Year 5
Total Interest Costs 5-Year Fixed Rate	$21,284	$20,784	$20,262	$19,717	$19,149
Total Interest Costs 3-Year Fixed Rate	$23,484	$22,965	$22,422	$21,851	$21,254
Interest Savings (5-Year Fixed Rate)	$2,200	$2,181	$2,160	$2,134	$2,105

If Rates Drop by 1.00% in Year 4

Now assume that rates drop by 1.00% in year 4. If you have a 3-year term, you will realize a lower interest rate when you renew. Instead of your next 3-year term renewing at 4.79%, it becomes 3.79%. In years 4 and 5, you save more interest costs by renewing. However, having a 5-year fixed rate still saves you approximately $1,737 in interest costs. 

	Year 1	Year 2	Year 3	Year 4	Year 5
Total Interest Costs 5-Year Fixed Rate	$21,284	$20,784	$20,262	$19,717	$19,149
Total Interest Costs 3-Year Fixed Rate	$23,484	$22,965	$22,422	$17,297	$16,765
Interest Savings (5-Year Fixed Rate)	$2,200	$2,181	$2,160
Interest Savings (3-Year Fixed Rate)				$2,420	$2,384

In comparison, assume you chose a 5-year fixed rate term instead of another 3-year term at renewal. If the rate is 1.00% lower, you would renew at 3.34% for the next 5 years. Now, you save significantly more in interest costs in years 4 and 5, and you also realize approximately $2,326 in interest cost savings by choosing the 3-year fixed-rate term initially and renewing to a lower 5-year fixed-rate term. 

	Year 1	Year 2	Year 3	Year 4	Year 5
Total Interest Costs 5-Year Fixed Rate	$21,284	$20,784	$20,262	$19,717	$19,149
Total Interest Costs 3-Year Fixed Rate	$23,484	$22,965	$22,422	$15,246	$14,753
Interest Savings (5-Year Fixed Rate)	$2,200	$2,181	$2,160
Interest Savings (3-Year Fixed Rate)				$4,471	$4,396

If Rates Increase by 1.00% in Year 4

Now assume that rates increase by 1.00% in year 4. If you have a 3-year term, you will realize a higher interest rate when you renew. Instead of your next 3-year term renewing at 4.79%, it becomes 5.79%. You are now paying significantly more interest in years 4 and 5 than the 5-year fixed-rate term and approximately $19,826 more in interest-carrying costs. 

If you choose a 5-year term when your 3-year term comes up for renewal, your rate would become 5.34%. Since the 5-year term has a slightly lower rate, you will realize approximately $15,755 more in interest-carrying costs by choosing the 3-year rate and renewing to a 5-year rate.  

	Year 1	Year 2	Year 3	Year 4	Year 5
Total Interest Costs 5-Year Fixed Rate	$21,284	$20,784	$20,262	$19,717	$19,149
Total Interest Costs 3-Year Fixed Rate	$23,484	$22,965	$22,422	$26,396	$25,755
Interest Savings (5-Year Fixed Rate)	$2,200	$2,181	$2,160	$6,679	$6,606

Frequently Asked Questions

Final Thoughts 

Deciding between a 3-year or 5-year fixed-rate mortgage will largely depend on your personal preferences, risk tolerance, short and long-term goals, and financial situation.  A mortgage professional can help by offering a customized solution and helping you choose the right mortgage for your needs. Whether you’re renewing or buying your first home, contact our mortgage professionals today for tailored advice.