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. For example, if you have a variable rate mortgage at prime minus 60 basis points and prime rate is currently 3.95%, then your mortgage rate would be 3.35%.
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).