Understanding Variable Rate Mortgages and Adjustable Rate Mortgages in Canada
If you’re looking to buy a home in Canada, you’ll likely need to secure a mortgage to finance the purchase. One of the key decisions you’ll need to make is whether to choose a mortgage with a fixed or variable interest rate. In this article, we’ll take a closer look at variable interest rate mortgages in Canada, including how they work, the pros and cons, and whether they’re the right choice for you. It is important to note that adjustable and variable get used interchangeably and basically mean the same thing.
There are two distinct types of mortgages that are characterized by their variable interest rates.
The first type is an Adjustable-Rate Mortgage (ARM) that features a payment amount that fluctuates with the changes in the prime rate. Typically, the payment adjustment occurs at the end of a full payment period, usually the payment after the upcoming one.
The second type is a Variable-Rate Mortgage (VRM) that has static payments similar to a fixed-rate mortgage, but the interest portion varies with fluctuations in the prime rate. As a result, the principal portion is pushed up or down. This type of mortgage also includes a Trigger Rate, which, when reached, signifies that the payment no longer covers the interest portion.
It is important to ask your mortgage broker or bank if the variable/adjustable rate mortgage product has a fixed payment or not. Below we will refer to both of these types of mortgages as Variable.
How Variable Interest Rate Mortgages Work
A variable interest rate mortgage, also known as a floating rate or adjustable rate mortgage, is a type of mortgage where the interest rate fluctuates with changes in the prime lending rate set by the Bank of Canada. When the prime rate goes up, your mortgage rate goes up, and when it goes down, your mortgage rate goes down. This means that your mortgage payment can vary over time.
The interest rate on a variable-rate mortgage typically consists of a discount off the prime rate. For example, your mortgage rate might be prime minus 0.5%. If the prime rate is 2.45%, your mortgage rate would be 1.95%.
Pros of Variable Interest Rate Mortgages
Variable interest rate mortgages offer several advantages over fixed-rate mortgages:
- Lower initial rate: Variable-rate mortgages often have lower initial interest rates than fixed-rate mortgages, which means your monthly payment will be lower at the outset.
- Potential savings: If interest rates drop, your mortgage payment will decrease, which means you could save money on interest over the life of the mortgage.
- Flexibility: Variable-rate mortgages often allow you to make extra payments or increase your payment amount without penalty, which means you can pay off your mortgage faster.
Cons of Variable Interest Rate Mortgages
Variable interest rate mortgages also have some disadvantages:
- Uncertainty: With a variable-rate mortgage, you don’t know exactly how much your mortgage payment will be from one month to the next, which can make budgeting more difficult.
- Risk of rate increases: If interest rates rise, your mortgage payment will increase, which could put a strain on your finances.
- Less stability: If you prefer stability and predictability in your finances, a variable-rate mortgage may not be the right choice for you.
Is a Variable Interest Rate Mortgage Right for You?
Deciding whether a variable interest rate mortgage is right for you depends on several factors, including your financial goals, risk tolerance, and current financial situation. If you have a stable income and are comfortable with the possibility of fluctuations in your mortgage payment, a variable-rate mortgage could be a good option. On the other hand, if you prefer the certainty of fixed mortgage payments, a fixed-rate mortgage may be a better choice.
Variable interest rate mortgages offer both advantages and disadvantages, and whether they are right for you depends on your individual financial circumstances and goals. If you are considering a variable-rate mortgage, it’s important to weigh the pros and cons carefully and consult with a mortgage broker to ensure that you make the best decision for your needs.
In Canada, the terms “variable rate mortgage” and “adjustable rate mortgage” are often used interchangeably and refer to the same type of mortgage where the interest rate fluctuates with changes in the prime lending rate set by the Bank of Canada. However, there are some subtle differences between the two.
In Canada, the term “variable rate mortgage” is more commonly used, while in the United States, “adjustable rate mortgage” is the more common term. The frequency and timing of interest rate adjustments can vary between variable-rate mortgages and adjustable-rate mortgages. With a variable rate mortgage in Canada, the interest rate can change any time the Bank of Canada adjusts the prime rate. With an adjustable-rate mortgage in the United States, the interest rate may be fixed for a certain period of time before it begins to adjust. Variable-rate mortgages are more common in Canada, while adjustable-rate mortgages are more common in the United States.
Despite these differences, both variable-rate mortgages and adjustable-rate mortgages function in a similar way and offer borrowers the potential for savings if interest rates go down, but also come with the risk of higher payments if interest rates go up. It’s important for borrowers to carefully evaluate their financial situation and risk tolerance when considering either type of mortgage. Consulting with a mortgage broker can help you make an informed decision about the right type of mortgage for your needs. They can help you evaluate your financial situation, compare mortgage products and lenders, and guide you through the application process.
For more information on Variable and Adjustable Rate Mortgages call 416-912-6200