Variable mortgages are a type of mortgage that is accompanied by a floating rate. In other words, the rate is not fixed throughout the length of the term. However, the payment on these types of mortgages can come with both “adjustable” or “fixed” payments.
In an adjustable payment scenario, the scheduled mortgage payment would fluctuate along with the rate while in a fixed payment scenario, the scheduled mortgage payment would remain the same. With a fixed payment, the composition of interest vs principal will adjust according to the amount of interest that is owed. For example, if the interest rate were to increase during the term of the mortgage, more of your fixed payment would go to service the interest and the balance of the payment would then go towards paying down your principal. This form of variable mortgage is kind of like a hybrid of variable and fixed mortgage types because it offers the “fixed Payment” peace of mind, while also allowing for fluctuations in the rate (obviously for those hoping the rates will go down, and not up).
It is important to note that there can be situations in which the interest rate hikes go too far in the wrong direction (up) that the fixed payment does not completely service the interest owed. This is known as the trigger rate. When this happens, the lender will likely come knocking to “readjust the payment” (increase it sufficiently) so that future payments can fully cover the elevated interest and principal.
Like fixed mortgages, Variable mortgages too have their pros/cons. Some of the advantages of variable mortgages include:
- Lower Initial Rate: one of the main benefits of a variable mortgage is that they usually offer a lower rate than their fixed rate counterparts. This is often appealing to homeowners because it also means that the payment obligation to the mortgage is also lower and more of the payment goes towards the principal vs interest. This is usually a very attractive selling point for first-time home buyers who want to make sure their payments are as low as possible.
- Potential for lower rates in the future. Let’s be honest, no one would want to get a variable mortgage if they believed their interest rate and mortgage payment was going to rise. So, it’s fair to assume that most variable mortgages are taken because of the belief that the rates will either stay the same or drop lower.
- Flexibility: these types of mortgages are often considered to be more flexible. For example, if rates were expected to rise or if you simply changed your mind about maintaining a variable mortgage, you can usually have the mortgage convert into a fixed rate mortgage, without any penalties if the term of the fixed mortgage is equal to or greater than the remaining term on your existing variable mortgage. However, if you had a Fixed mortgage and wanted to switch to a Variable, you wouldn’t be able to do so, unless you wanted to trigger a penalty.
- Short-term solution: these mortgages can also be a good avenue for those that want the flexibility to sell their home in a shorter time horizon, or who are not sure they would be able to take their mortgage to the full term. The reason for this being a better option is that the penalty to break a variable mortgage is typically capped at 3 months’ worth of interest penalty. A fixed mortgage on the other hand can have severe penalties depending on how the fixed mortgage penalty is calculated (3 months interest vs. Interest rate differential).
These are just a few reasons why a variable mortgage might be good for some homeowners. It is, however, important to note there are also risks to taking on a variable mortgage and it’s always good to make sure you understand both advantages and disadvantages so you can make the right decision as it relates to your situation and your tolerance with rate fluctuations. The great news is, we’re always here to help you navigate the decision process to make sure you are setting yourself up for a successful path in your home ownership journey towards paying off your mortgage altogether! Give us a call – at 905-455-5005.