What is a variable rate mortgage?

In Credit by CreatingWealthYoung0 Comments

When it comes to mortgages, there are two primary types; variable or fixed rate mortgage. A variable rate mortgage is one which the interest rate is subject to change, unlike a fixed rate mortgage where the rate is constant for the entire term.

Variable mortgages can be either an open or closed term mortgage. The main difference between the two is their corresponding prepayment cost if the mortgage is broken or paid off before the mortgage term.

An open variable mortgage will have a higher interest rate compared to a closed variable mortgage due to the fact the mortgage can be broken at any time without any prepayment penalty (cost to break the mortgage early). With a closed variable mortgage, the interest rate will be lower than a comparable open variable rate mortgage. However, the prepayment penalty will be 3 months of interest charge with a closed variable rate mortgage. Closed variable rate mortgage can also be advantageous when it comes to refinancing or porting a mortgage as it’s possible for prepayment charges to be eliminated while securing a lower interest rate by choosing a variable closed mortgage.

The common thing both an open and a closed variable mortgage share is their interest rate is subject to change. The rate you secure is a discount off the current prime rate. For example, the prime rate is currently 2.700% and assuming your bank offered you a 70 basis point discount off the prime rate, your mortgage rate would be 2.00%.  This rate is subject to change base on prime rate movement. In the event prime increase to let’s say 3.00%, your new rate would work out to 2.20% (3-.70). This is due to the fact variable rate mortgages are a discount off the prime rate.

In an effort to avoid individuals signing up for mortgages they can’t afford if the prime rate increases, individuals have to be qualified at a higher interest rate in order to get a variable rate mortgage. As it stands, CMHC qualifying benchmark rate for a variable mortgage is at 4.64%. That means, anyone looking to qualify for a variable rate mortgage must first be able to qualify for the same mortgage at 4.64% interest rate.

Going with a variable rate mortgage can offer you a lower interest rate and greater flexibility. It’s a good option particularly if you know you might have to break your mortgage before the term ends.

The key to making a variable mortgage work is to first understand your rate could be subject to change should things significantly change in the economy. Spend some time to develop a plan in the event things change to ensure you can handle a couple of percent increase.

Lastly, this is really a personal preference from my experience. I think it’s important you pick a mortgage option you feel comfortable with. Don’t feel pressured to pick a variable rate mortgage if you do not feel comfortable with it. You are the one who will be responsible for making payments and you should pick what you feel will work best for you.