In this article I’d like to focus on Variable Mortgages. For the most part everyone knows what a Fixed Rate Mortgage is, as its the most common mortgage product. For those that don’t, it’s a mortgage that locks in your rate for the duration of the term. Whether the term be 1, 3, or 5 years, that’s the rate you get. You cannot switch from a fixed rate to variable, unless you refinance with a new lender. This would come with penalties if you did so before the term is up.
Variable Rate Mortgages are based on the Bank of Canada’s prime rate which fluctuates throughout the year. The variable mortgage interest rates are consistently lower than fixed rates. They pose less of a risk to lenders because these rates adjust with the prime rate market.
There are two types of Variable Rate Mortgages, the first is a Constant Payment and the second is a Variable Payment. With a Constant Payment your payments will stay the same but the amount of principal which is paid off fluctuates based on the interest rate change. The drawback is, this can throw off a 25 year payment schedule if the interest rate is high for a long period of time. If this happens the borrower will have the option to increase monthly payments to offset the change.
With a Variable Payment, the amount of the monthly payment fluctuates to pay more or less interest but keeps the principal payments consistent. This will maintain a 25 year amortization schedule and possibly even increase cash flow with low rates. Also keep in mind, most lenders will allow the borrower to switch from a variable rate to fixed rate, but not the other way around.
Consider questions like ‘are you able to afford your mortgage if the rates go up?’ The risk can be worth the reward in the case of a Variable Mortgage, but it should never be a gamble. Ensure this type of mortgage works with your lifestyle.
I’ll provide an example to illustrate the possible benefits of going with a Variable Rate Mortgage. The rates provided are current rates of one specific Lender who will remain anonymous.
In this scenario, the variable rate is going to go up 4 times over a 5 year period.
0.25% increase after one year, 0.25% increase after two years, 0.25% increase after 3 years, and 0.25% increase after 4 years.
A mortgage in the amount of $350,000 at a 5 year fixed rate of 3.69% amortized over 25 years.
Monthly Payments – $1,782.73
A mortgage in the amount of $350,000 with a variable rate of 2.95% amortized over 25 years.
Monthly Payments – $1,647.39 (over the next 5 years increases at total of 1% due to rate changes)
|Average Monthly Payment||$1,782.73||$1,735.47||$47.26|
|Total Payments Over Term||$106,963.80||$104,128.04||$2,835.76|
|Total Principal Paid||$46,977.87||$48,198.49||$1,220.62|
|Total Interest Paid||$59,985.93||$55,929.55||$4,056.38|
|Principal Ending Balance||$303,022.13||$301,801.51||$1,220.62|
The total amount saved on interest through the Variable mortgage is $4,056.38. This is calculated over 5 years assuming the interest rate consistently rises 0.25% each year.
If you have more questions don’t hesitate to reach out, I’m always available to discuss mortgage options. I’d be happy to go into more detail about anything I’ve addressed in this blog or any other scenario.