If you prefer flexibility in your mortgage rate, a variable rate mortgage is exactly what you are looking for. from time to time a variable rate mortgage will save you money and free up cash flow which allows you the ability to put money back into your home, your future.
Today we take a closer look at a variable rate mortgage definition, how a VRM works, along with who might benefit the most from this type of housing loan.
Definition of a Variable Rate Mortgage
Financial experts define the variable rate mortgage as a loan where the “interest rate can change during the life of the loan.” Most Canadian loans will be calculated based on the Bank of Canada Prime Rate, the variable rate is no different. It’s important to point out that each financial institution has its own Prime Rate, which is based on the Bank of Canada Prime Rate. You will see that a lot when you view various lender or broker website interest rates.
The variable rate mortgage has many elements to it, including: the interest rate index, initial rate period, initial adjustment cap, minimum lifetime rate, maximum lifetime rate and adjustment interval. The initial adjustment cap is the maximum that the rate can rise during the first adjustment. The adjustment interval could be monthly or annually. It’s a bit confusing and a little beyond this article, just be sure to ask your mortgagor about the details of each of these.
Variable Rate Mortgage Advantages
Less Interest Payments
The most obvious VRM advantage involves how much you pay. Variable rates allow the payment to adjust the loan over time meaning you pay less interest.
Lower Income Approvals
Another advantage is a variable rate mortgage allows individuals with slightly lower income levels to qualify since the rate is usually lower allowing more room to borrow.
Resell the “Fixer-Upper”
Although the most common term for Canadian mortgages is five years, some individuals might want to sell their house before it expires. A Variable Rate Mortgage has the option to be ‘open’ where you can pay it out earlier than the original term without penalty. Handy men might remodel an old house and then resell it for a healthy profit.
The variable rate mortgage offers more flexibility. The fixed rate mortgage tends to be a “one-size-fits-all” housing loan. Circumstances can change quickly and a variable rate mortgage can allow you to get the lowest interest rates in the market. You also may have the freedom to convert to a fixed rate mortgage to lock in a great rate.
When homeowners only had fixed rate mortgages, they would usually forget about their loans for years. Since the variable rate is ever-changing, homeowners are more likely to shop around and keep track of the prevailing interest rates. They might even try to gauge whether the Canadian Bonds (Government of Canada debt market) will see their prices rise or fall.
These floating rates have created a robust refinance market. Homeowners are cheering for lower interest rates, so they can refinance and save money over the long run.
To summarize, here are the key advantages of the variable rate mortgage:
- Lower Interest Payment
- More Opportunities
- Usually Lower Rate
Are Variable Rates More Risky?
Every month, homeowners balance their budgets and this is very easy to do with a fixed rate mortgage. The entire home value is amortized over the entire time period, when you have the stable fixed rate mortgage. This may or may not be true with a variable rate mortgage. Here are some key disadvantages to the variable rate mortgage:
- Higher Risk if rates go up
- Amortization Skewed
If you are struggling to make ends meet and the variable rate increases, you could be in serious trouble, look at locking in a rate for the remainder of the term.
Should Cautious Homeowners Choose Fixed Rate Mortgages?
Experts suggest that if you are a “worry wart” who becomes nervous with uncertain conditions, then a fixed rate mortgage is probably better. You don’t need to keep track of changing interest rates and you can project your monthly housing payment for the life of the mortgage.
Variable or fixed rate mortgage – having options is always beneficial. Some mixed mortgages even combine the two rates. Read the fine print and choose an interest rate that is best for your credit score, psychological well-being and monthly budget.