A variable mortgage is characterized by its adjustable interest rate. The rate changes periodically and is based on a specific index that reflects the cost to the lender of borrowing on the credit market. The loan is typically offered at the lender’s rate which is equivalent to the prime plus a certain percentage.
In Ontario, variable mortgage rates are popular because they typically come with lower rates than fixed rate mortgages. The reason is that, in a variable rate mortgage, more of the risk is assumed by the borrower than the lender. If rates rise, the borrower is on the hook for the increased cost. If rates drop, the borrower reaps the reward of a lower payment. The lender makes the same amount off the loan regardless of how the markets perform.
In contrast, with a fixed rate mortgage, the risk is assumed by the lender. The borrower pays a premium for the security of a fixed rate but is in turn protected from rising interest rates. In general, a variable mortgage is preferred in a poor economy when interest rates are being lowered to stimulate the economy.
There are a few key items you should look at when choosing a variable rate mortgage. The first thing is the beginning interest rate. There is usually a promotional or adjustment period at the beginning where the rate is scheduled to remain unchanged. The rate resets at the end of that period and then changes at agreed upon intervals, usually monthly.
The index rate is another important item to note. Most lenders tie the rate to changes in the index rate, so it’s helpful to know where this base number is coming from. Your interest rate may be expressed as the prime plus a percent, where the prime is the index rate. This additional amount is formally known as the margin.
Interest rate caps are probably the most important and interesting thing a borrower can ask about. The cap is the limit on how much interest can be charged at the end of each period over the life of the loan. A good way to look at the cap is the”worst case scenario.” That way, you know the maximum amount you may ever have to pay.
If your contract allows for a conversion, this is the clause that allows you to convert the variable rate mortgage into a fixed-rate mortgage at a certain point during the contract period. This is a helpful feature for those who take on the mortgage during a period of economic downturn. You take the adjustable rate mortgage for a lower rate than a fixed rate mortgage to save money and then convert it to a fixed rate plan when interest rates are lower.
It’s no secret that mortgages are complicated. If you think that a variable rate mortgage may be right for your financial needs, click on the link below to get in touch with an Ontario mortgage specialist who can discuss your situation with you and determine what the best product is for your needs. You’ll also have access to the latest rates, which can help you make an informed decision.