A variable mortgage is where the rate fluctuates based on prevailing rates during the term. When the mortgage loan is taken out, the rate is fixed and based on the current variable interest rate. The mortgage is then reviewed periodically (e.g. once a month).
Some lenders adjust the rate quarterly, while others adjust it monthly. When the market changes or the prime rate changes, the mortgage interest rate also changes ?either up or down. In most cases, lenders fix the rate based on an index. This index can be the prime rate, the cost of living index, or the cost of funds index. Ask your lender what index is used and how it calculated.
Deciding between a fixed or variable rate mortgage hinges on your tolerance for risk. If you prefer to go to bed at night feeling assured that you will pay a fixed amount every month enabling you to plan a budget, then a fixed rate mortgage is for you. However, if you want to take advantage of (typically lower) monthly payments and don believe that rates will increase during the term of your mortgage, then variable is the way to go.
Advantages of a Variable Rate Mortgage
Variable rate mortgages align with the base interest rate. So if there a certain period of time when interest rates are going down, variable works to your advantage because your loan has a lower rate ?and hence, lower monthly payments. Also, with variable, your payments go towards the payment of capital when interest rates are low -- making it possible for you to pay off the mortgage sooner.
On top of that, there are several options available in a variable rate mortgage -- unlike a fixed rate mortgage, the terms and payment amounts may be adjusted.
And finally, when rates start going up, most lenders will give you the option of converting into a fixed rate before your term is over. There will be some penalties involved. However, the financial penalties may actually be worth it if variable rates are heading significantly above prevailing fixed rates.
Disadvantages of Variable Rate Mortgage
The principal disadvantage of a variable mortgage is that if interest rates go up, your interest rate on the mortgage also goes up (and so do your payments!).
Also, variable mortgages may be more difficult to manage because of caps and limits. You can ask your lender to establish a cap on the interest rate (i.e. the maximum increase in the rate) and a limit on your monthly payments (if the interest rate goes up resulting in higher monthly payments). Agree to caps and limits that youe financially comfortable with.
And of course, given that interest rates fluctuate, it becomes more difficult to stick to a budget or payment schedule.
What Banks Don Tell You About Variable Mortgages
Borrowers who are concerned about making smaller monthly mortgage payments will be attracted to the variable rate mortgage --and with good reason! This is because when interest rates are low, the payments made go towards paying down the capital. The idea, however, is to do your homework on variable rate mortgages because theye not all structured the same way. Some banks offer more options than others; some choose the interest rate on the prime rate index, while still others choose the rate on the cost of living index.
If you don ask your lender the right questions, you might not be getting the full picture because some lenders think that it either too cumbersome or complex to explain the technicalities and mathematical formulas. But before you sign that variable rate mortgage contract, make sure you know what youe getting into! My best advice? When in doubt: Ask, ask, ask!
Many financial experts agree that the variable mortgage can save borrowers thousands of dollars a year. However, banks often use fear tactics to lure borrowers into fixed rate mortgage because, frankly, they earn a lot of interest from fixed rate mortgages.
What banks don usually share with borrowers is that the days of very high interest rates ?the kind we saw in the yperinflation?of the late 70s and 80s are long gone. And so there is really no expectation that wel be seeing even 7, 8 or 9% rates in the decades to come. Even at the time of this writing, interest rates are still hovering down around historical lows.
Another key thing that banks often don tell their clients is that you can possibly save a lot on interest costs and monthly payments by being creative. For example, when you first apply for a mortgage, you can opt for a short-term fixed rate mortgage of, say, 6-12 months ?but with the option of paying it off anytime (e.g. open). Or, you can take out a variable rate mortgage that is 2 percentage points less than the fixed rate mortgage. Then, when interest rates fall and you find a very attractive rate, you can lock into it for a longer period (say, 7-10 years).
An of course, banks don want you to know that there are dozens of lenders out there who will compete to offer you the best rate. They also don want to tell you that when your mortgage period ends, you can shop around ?you don have to stick with your bank! Remember: while your banker represents his or her institution, a mortgage broker represents many lenders and is in a better position to look for the best mortgage rate for you. Established and reliable mortgage brokers like me have a vast network of people and information, and know where to find an excellent mortgage loan ?which is one that you can afford, and one that doesn sting you with any unwanted urprises?later on,beats by dre studio.
My advice? When youe looking for a variable mortgage, it pays to shop around. Take the time you need to gather as much information as you need, and look at different scenarios and consequences.
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