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What is a Variable Rate Mortgage and How Does it Work?
If you’re looking for the lowest possible mortgage rate and don’t mind taking on a bit more risk, then a variable rate mortgage might make sense for you.
As its name suggests, with the variable rate mortgage, the mortgage rate is variable – it can change during your mortgage term. The rate on variable mortgages is based on prime rate, the rate lenders offer to their most creditworthy clients, plus or minus a spread.
A lender’s prime rate is influenced by the Bank of Canada’s overnight lending rate. When our central bank changes interest rates, the banks tend to follow suit by changing prime rate by the same amount.
As mentioned, if prime rate were to change, so too would your mortgage rate. For example, using the same example from earlier, if prime rate went up 25 basis points to 4.20%, then your mortgage rate would also go up by 25 basis points to 3.60%. Likewise, if prime rate were to go down by 25 basis points to 3.70%, then your mortgage rate would also go down by 25 basis points to 3.10%.
With some variable rate mortgages, when prime rate changes, your mortgage payment will also change. For example, if prime rate goes up, your mortgage payment will go up as well. However, with variable rate mortgages offered by other lenders, your mortgage payment may stay the same (although more of your money will go towards interest and less towards principal).
Why You Might You Choose a Variable Rate Mortgage
If you want to save money on your mortgage and the possibility of higher mortgage rates doesn’t keep you up at night, then variable rate is worth serious consideration.
5-year variable rate mortgages are almost always offered at a lower mortgage rate than 5-year fixed rate mortgages. The lower mortgage rate up front can help you save some decent money in mortgage interest over your mortgage term and the life of your mortgage.
With a variable rate mortgage, you usually have the ability to lock in your mortgage at any time during your mortgage term. You might lock in your mortgage if mortgage rates have risen (or you anticipate them rising). You can typically lock in to a fixed rate of equivalent length to the time remaining on your variable rate mortgage. For example, if you have 3 years left on your variable rate mortgage, you could lock into a 3-year fixed mortgage. This can protect you from further rate increases.
Is there a chance you might have to break your mortgage? Then again, variable rate mortgages offer an advantage over fixed rate mortgages. Variable rate mortgages tend to come with less onerous mortgage penalties. Typically, you’ll only have to pay a penalty of 3 months of interest for breaking your mortgage before the end of its term.
Lastly, if you plan to pay off your mortgage in a short time period (less than 5 years), then variable rate can make sense as well since you can take advantage of the lower rate with less risk (since you’re paying off your mortgage sooner rather than later).
By The Numbers:
For homes bought with a mortgage in 2018, 30% of homebuyers chose variable rate mortgages.
Source: Mortgage Professionals Canada
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