As property owners, you are best-suited to make the decision on the term since you really know what you plan to do with your asset. However, there are options that exist that can help provide guidance.
They can generally be summarized in terms of one to three categories: short, medium and long. Shorter terms are usually between one and three years while medium terms can range from five to seven years.
Long terms are generally 10 years or longer.
Several reasons for short terms
Short terms are usually taken for a few reasons. They can generally be open mortgages, and the borrower can pay out the mortgage at any time (for a refresher on mortgage penalties click here).
The most common reason revolves around the owner potentially selling the property at some point during the term. In this case, instead of locking the borrower into a longer term that is closed to prepayment, the lender would provide the shorter-term financing.
If at any time during the term the owner of the property sells the property, they can transfer ownership and pay out the mortgage on the property. The other reason may involve the owner of the property looking to reposition the asset by improving it and increasing the overall income derived from the property.
In this case, the owner is also not locked into a long-term mortgage that cannot be paid out. By taking a shorter term and repositioning the asset, the owner can then refinance the property at a later date and maximize the amount of debt on the property, thereby getting as much equity out of the property as possible.
Closed to prepayment
Mid terms can also be common. However, in taking these terms the owner has to realize the mortgage is closed to prepayment and would have a prepayment penalty.
The first reason for mid terms generally revolves around the uncertainty an owner has about the future they have with the property. Since interest rates are still at all-time lows, property values are also at all-time highs. If the owner is thinking of selling the property but unsure if they want to do so, they may take a mid term which allows two things.
First of all, it allows the owner to take advantage of the low interest rates while he makes a decision in the future. With a five-year term, the owner can wait a few years before he or she really needs to make a decision on the property.
In the event they do sell the property after five years, they can avoid the prepayment penalty associated with paying out the mortgage and having the buyer of the property assume the mortgage. The owner can then sell the property and the buyer can take advantage of the low interest rate on the mortgage.
Stagger mortgage maturity dates
The second reason perhaps involves matching. Owners with multiple properties with different maturity dates may take shorter or longer terms so all of the mortgages in their portfolio do not mature at the same time.
In this way, the owner can lock the mortgage down for a medium term and think about it again at the end of the term.
Longer-term mortgages are generally reserved for 10 years or more. The primary reason for taking longer terms are based on current interest rates.
In these situations, the owner generally is not looking to sell the property any time during the mortgage term.
The owner can take advantage of the low interest rates available and lock the mortgage for a long term for 10, 15 or even 20 years. By the time the term ends, it is likely the market will be drastically different and market interest rates will be entirely different.
Only the owners will know the motivations when choosing a term, but it never hurts to run the motivation by your lender to get their guidance as well.
Read more from: Capital Commentary