What is a Variable Rate Mortgage?

What is a Variable Rate Mortgage?

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Very few people can afford to buy a home outright so, for most, getting a mortgage is the only way to go. It’s no small commitment, however, and once you’ve agreed to a take out a loan with a lender, you’re obliged to follow through with it.

Getting an understanding of mortgages is essential, especially since there are a number of different options to choose from. In the first part of our series of mortgage specials, we looked at fixed rate mortgages. This second part takes a look at how a variable rate mortgage differs, as well as weighing up the pros and cons of taking one out.

The Basics

With fixed rate mortgages, the monthly payments are locked in for the duration of the term, but a variable rate mortgage may continuously adjust to match market rates. This can work in your favour if market rates drop, but it can also work against you if they experience a sudden increase.

When interest rates are low, you can pay off more of your mortgage and reduce your amortization period. If rates rise, you’ll pay more each month, and you may want to refinance your loan sometime in the future.

The Benefits of a Variable Rate Mortgage

The main advantage of taking out a variable rate mortgage is that the total amount of interest you’ll be required to pay may be lower than with a fixed rate mortgage. Variable rate mortgages may begin with lower repayments than fixed rate mortgages — saving you money, at least for a while. In favourable market conditions, variable rates will remain low and may drop even further, while fixed rates will remain the same.

During periods of low interest rates, you’ll be able to pay off more of your mortgage, reducing your amortization period considerably. In this way you may become mortgage-free quicker than with a fixed rate mortgage.

The Disadvantages of a Variable Rate Mortgage

It’s true that when interest rates are low, a variable rate mortgage is extremely attractive, but there’s a flip side to that coin. Interest rates can rise sharply and in a short period of time. If this happens, you’ll need to pay more and more each month in interest, until things settle down.

You need to be prepared for increases, which can put financial strain on a tight budget. This requires forward planning and ensuring you have a buffer zone. It can be stressful watching interest rates creep up, and if you’re the kind of person who would lose sleep at night worrying, a variable rate mortgage might not be the ideal choice for you.

Making the Most Out of a Variable Rate Mortgage

When rates are at an all-time low, you might be tempted to go for a variable rate mortgage. However, this may not be wise, as there’s a higher chance they will rise rather than fall in the future. A good rule of thumb is that if there is no more than a 1% difference between a variable and fixed rate mortgage, it’s wise to go for the latter.

It’s a good idea to not just make the minimum monthly repayments if you do choose a variable rate mortgage. Set your payments to the same rate as current 5-year fixed rates. This provides a buffer zone in case rates rise, and can also help you pay your mortgage off quicker if rates remain low.

While there’s a certain element of risk involved with variable rate mortgages, the rewards can pay off. Thorough research and forward planning is necessary to make it work, but if you expect an increase in income, or can already comfortably pay the minimum payments, a variable rate mortgage could be the choice for you.

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