A variable rate mortgage is one of two main types of mortgages that exist today, the other being “fixed” rate mortgages. The main difference between the two is that, unlike a Fixed rate mortgage where the interest rate is “fixed” for the selected term, a variable rate mortgage can fluctuate (both in rate and subsequently payment). This fluctuation in the mortgage rate can be beneficial when the market experiences a reduction in the prime rate and the opposite is true if the prime rate increases. Naturally, the risk of increasing interest rates means increased payments can cause many home owners to experience higher levels of financial stress when making the corresponding mortgage payments.
So why do many home buyers/owners choose to go with a variable rate mortgage?
Mainly due to the possibility of paying less interest during the term and perhaps the lifetime of the mortgage. At any given time in the market, there is a difference between fixed and variable rates that are offered, with variable rates having a discount off the prime rate (in other words, prime minus “X”). This combination tends to yield a net rate that is lower than the in-market fixed rate that is being offered. Since variable rates tend to be significantly lower than fixed rates at the onset of the mortgage, many borrowers are attracted to this type of mortgage because their respective payments would (at least at this time) be lower than the present fixed rate. Of course, only time will tell if the variable rate will “hold” as being a better choice throughout the term of the mortgage.
In the event the prime rate does rise, most lenders who offer variable rate mortgage allow their borrowers to switch their mortgage into a fixed rate. Having said that, the borrowers would be subject to receiving the applicable in-market fixed rate at the time of converting their mortgage, not what was originally offered at onset of the mortgage (when the variable option was taken). In any case, this allows borrowers to at least mitigate their risk, by converting their mortgage into a fixed rate mortgage, even if it is not as low as what was originally offered.
On another note and as briefly mentioned above, another reason why people choose to go with a variable rate mortgage is at the possibility of having even lower interest, should the market prime rate drop in the future. This would yield an even greater potential of saving on the interest paid on the principal of the mortgage.
Finally, an interesting perspective to consider, especially in a market with increasing rate conditions is that a variable rate mortgage allows for borrowers to gradually adjust to increased payments if/as they occur. With a fixed rate mortgage, the payments remain constant throughout the term, but also only for that term. In the event that mortgage rates have increased over time, the borrower would face a “shock” of sorts at maturity/renewal time. In fact, they would need to abruptly cope with the new higher payments all at once….
There are pros and cons that exist with any mortgage but if you would like to discuss your mortgage needs, we’d certainly be here to help you. (905) 455-5005.