Variable Rate Mortgages (VRM)
Variable Rate Mortgages offer a unique opportunity to Canadians for saving on the interest they pay on their mortgage, provided that certain factors go their way. Usually, Variable rates work out lower than Fixed Rates at the outset.
When comparing mortgage rate type today with 2018, 27% of Canadian mortgage borrowers had borrowed a Variable rate mortgage, which was up from 21% in 2016.
Due to COVID 19, as we prepare for a future where flexible monthly mortgage payments act as saviors, variable rates are going to become even more popular especially when house prices are rising and average home price in an area increases.
This post speaks about variable rate mortgages, their long and short term benefits, factors that determine variable rates, who should opt for it, and many other relevant topics. Let us start off by understanding what a variable rate mortgage actually is.
Variable-rate mortgages depend upon the Bank of Canada rates. Click here to learn more.
BoC Rate Update (%): March 08, 2023
New BoC Rate = 4.50%
Today’s Prime Rate = 6.70%
Next Announcement = April 12, 2023
What are variable rate mortgages?
A variable rate mortgage is one where the rate of interest charged on the loan is not fixed. The rate will fluctuate throughout the loan term on the basis of an underlying benchmark or an index that changes at regular intervals.
Types of Variable Rate Mortgages
There are 2 variable rate mortgage options for Canadians: one in which the amount of payments change according to the variable rate, and the other in which the payment remains constant.
In the second case, the fluctuation in interest rates will impact the proportion of the payment that goes towards paying off the principal and interest. If the rates decrease, then more of the payment would go towards paying off the principal.
If rates increase, then more of the payment would be allocated to cover the interest.
The loan contract would specify when and how frequently the variable interest rate could be adjusted, and may also set a limit on the increase and decrease in the rate.
Caution - Variable Rate Penalties
Knowing how 3 months penalty is calculated, will help you save heaps of money. Inquire if your bank calculates the penalties off their prime rate or contract rate. Its 2 different beasts so be informed.
- Variable rate mortgages typically will benefit the borrower in a declining market as the interest rates will decrease in such a market where the demand for money is little.
- Variable interest rates have historically been lower than fixed rates. Borrowers who take out this loan usually pay less than fixed mortgage rate borrowers
- You can get a variable rate mortgage for purchasing a new property and for refinancing the existing mortgage, irrespective of whether the property is a primary residence or an investment property. So you can essentially move on to a cheaper interest rate loan anytime.
- The greatest benefit of a variable rate mortgage is that the penalty for breaking a variable rate mortgage is equivalent to only 3 months worth of interest payments. So if you find a better mortgage deal, or if you want to prepay your loan, you can do so without worrying about hefty penalties.
However, there are certain lenders and products which have restrictions on what you can do with the mortgage term. So keep an eye out for that.
Variable rates have a direct relationship with the Bank of Canada lending interest rates (this rate, also known as the overnight rate, is used by banks to lend money to each other.) Canadian banks also use this rate to determine their own prime rate, which is the rate they offer to customers with a strong credit history and goodwill.
When the Bank of Canada lending rate increases, the Prime rate increases with it & vice versa.
Variable rate mortgages are always offered as percentage points higher or lower than the given prime rate.
Allow us to explain the rates today with an example.
Today the prime rate (P) is: 6.70% (Jan 25, 2023)
If you have a strong credit history, the bank may offer you a discounted rate which is, say about 0.50 percent lower than the Prime Rate.
So the Variable rate would be: P – 0.50% = 6.20%
A secure variable rate Line of Credit, on the other hand, may be offered at half a percent higher than the prime rate, i.e. at 7.20%
Every lender has its own discounts when it comes to these rates.
You can keep tabs on this official Bank of Canada web page to learn about interest rates for existing and new mortgages and to anticipate future trends.
When should you opt in for a variable rate mortgage?
You should for a variable rate mortgage if:
- You are comfortable with fluctuating payments and have the financial flexibility to deal with it
- You want the option to pay off your mortgage early without paying hefty penalties. You also must have a plan to accumulate the capital to pay off the mortgage.
- You are stuck in a high interest rate loan and are looking to break your mortgage and leverage the benefits of a variable rate loan.
When Not To Go With Variable Rate?
DO NOT go for a variable rate mortgage if you have a tighter budget, financial liabilities, inconsistent cash flow, and inability to handle fluctuation in monthly payments.
● The most important thing to consider with a variable rate mortgage is your own financial future. You must know whether you have the financial strength to deal with fluctuating payments a few years down the road.
● Compare the rate of interest offered to you against the rate of interest for a similar term for a fixed rate mortgage. If the difference isn’t a lot, then you should think twice before opting for variable rates.
● Whether you want a closed term mortgage or an open mortgage. An open mortgage will come with a much higher interest rate than a closed mortgage. But please note that with an open mortgage, you will be able to pay the loan in its entirety or break the mortgage at any time without notice, even within 12 months or so.
● Check if the bank is making any special offer. Quite often, banks are willing to offer a rate lower than usual. All you need is a solid mortgage broker by your side who can take over the negotiations and get you an attractive deal. (having a solid credit rating and goodwill also helps a little)
A fixed mortgage rate is one where the rate of interest does not change throughout the term of the period. As a result, regular payments also stay fixed.
If you are looking for stability, security against a potential long term increase in interest rates, and fixed monthly payments, then you should seriously consider going for fix mortgage rates.
We caution you against going after the lowest 5 years fixed mortgage rates. It lowers your monthly payments but may come with hefty penalties.
Always ask for posted rates and the discount a lender is giving you upfront when opting in for fix mortgage rates. Your spread between posted rates and rate on your commitment dictates the early payout penalties.
A particular type of variable rate mortgage, or rather a middle path between fixed and variable rates, known as an adjustable rate mortgage could be a great option to consider for borrowers looking to benefit from the best of both worlds.
Under this structure, the interest rate remains constant for the first few years of the term, after which the loan becomes a variable rate mortgage.
Final thoughts
A variable rate mortgage is not for everyone. But for those who can manage fluctuating payments without putting a burden on their budget, it is a great option to have.
Choosing the right mortgage product type with the right term including amortization of 25 years / 30 years and payment schedule can help you pay your mortgage faster.
Hopefully by know you have given a deeper thought and have understood the real impact on pre payment penalties when your bank uses prime rate in comparison to your contract rates.
Having a mississauga’s mortgage broker expert by your side will ensure that you are served well and don’t end up getting trapped with the lowest rate alone.
To know more about Mississauga mortgage rates and what we can do for you, connect with us today.
