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A mortgage rate is the price of your mortgage loan. It is like the price of bread and burgers but converted in percentages. The dollar value of this rate becomes the interest fee attached to your regular monthly payment.
The mortgage rate is the price you pay for a mortgage loan. This rate can either be variable or fixed.
Mortgages with variable rates are called variable-rate mortgages, and mortgages with rate pricing are fixed-rate mortgages.
You can review our fixed-rate mortgage guide to understand how it works and if it’s a better option for you.
In this guide, we will cover variable-rate mortgages, what they are, their advantages and disadvantages, different types of variable-rate mortgages, and many more.
Let’s start by understanding what a variable rate mortgage is.
It is weird for the sheer number of individuals I have met who are actively searching for a house and applying for a mortgage but know little to nothing about the interplay of a mortgage rate. They just want to get a low mortgage.
Understanding the mechanics of a mortgage rate will help you make the right mortgage decision. By doing the working of a mortgage rate and its implication to you, you can best make the right choice of a fixed or variable rate mortgage to go with.
When you go to the grocery store to buy apples, you can buy a bag for a fixed price. Every pack of apples has a fixed price, or you can choose to buy selected apples. These apples are weighed and priced by the apple’s total pound.
A mortgage is similar. The mortgage rate is the price of the loan. It fluctuates by a few factors.
In a grocery store, you are charged a dollar amount, while in a mortgage, you are charged a rate. When you apply this rate to the loan amount, you will get the dollar cost of the loan.
The mortgage rate on your variable rate mortgage comprises the lender’s prime rate and a rate margin. The lender’s Prime Rate is the variable section, and the Rate Margin is the fixed section. Your margin will never change during your mortgage term.
The lender’s Prime Rate is the variable portion: This prime rate is connected to the Bank of Canada’s Prime Rate decisions. A change in the Bank of Canada Prime Rate will trigger a change in Lender’s Prime Lending Rates, resulting in a change to your mortgage rate.
The rate margin is the fixed portion of your quoted rate. The rate margin portion is quoted at a premium (+) or a discount (-) to the lender’s prime rate. Again, your rate margin will not change even if the prime rate goes up or down. Your rate margin will depend on various factors such as your credit score, your credit score, intended use of the property, and your qualification ratios.
The rate for variable-rate mortgages is quoted as a discount or premium to the lender’s prime rate.
P+0.12% means your rate is priced at a 0.12% premium to the prime rate. The prime rate now is 2.45%. Therefore, we can rewrite the quote above to 2.45% + 0.12% = 2.57%. Thus, your mortgage rate quoted at P+0.12% is 2.57%.
P-0.07% means your rate is priced at a 0.07% discount to the prime rate of 2.45%. Also, we can rewrite this quote as 2.45%-0.07% = 2.38%. Thus, your mortgage rate quoted at P+0.12% is 2.38%.
Variable-rate changes can change monthly or quarterly, depending on the economic conditions. There is no specific schedule for when the variable rate will change, making it difficult to predict the rate tomorrow, next week, next month, or even next year.
Compared to a fixed-rate mortgage, your mortgage rate would not change even if the market rate went up or down. It is easy to plan your financial needs with a fixed-rate mortgage, making it less risky than a variable-rate mortgage.
The fact that you cannot predict how variable rates will move with certainty is a risk that explains why lenders are willing to price variable-rate mortgages at a lower rate than a similar fixed-rate mortgage.
A variable-rate mortgage can be a better choice if you can handle the unpredictable nature of its mortgage rate.
Generally, its mortgage rates are low compared to a comparable fixed-rate mortgage, the prepayment penalty is much less, and what is more, most lenders in Canada offer you the option to switch to a fixed-rate mortgage.
Borrowing a variable-rate mortgage may benefit you in a fallen market-rate environment. The lower market rate will lower your overall rate on your variable-rate mortgage, increasing the portion of your payment assigned to pay down your mortgage loan.
However, variable mortgage rates may keep up at night, especially when the anticipation of the Bank of Canada’s rate increase is in the air.
Below are the advantages you can enjoy by choosing a variable rate mortgage and a few disadvantages to watch out for as you make your mortgage rate decision.
This is the shortest variable-rate mortgage term. 6-month variable-rate mortgages come with an open term embedded in them.
As an open-term mortgage, you can pay off part or all of the mortgage anytime during the six months without having to pay prepayment charges. This type has one of the highest mortgage rates, given its short length and prepayment privilege.
A 6-month variable-rate mortgage may be the right option for you if you are hoping for a huge payout to pay off your entire mortgage after the mortgage term. Real estate investors and house flippers most often use this term.
If you are looking for a medium-term variable-rate mortgage, a 3-year variable-rate mortgage may be the right option.
Compared to a six-month term, a three-year provides you with enough time to settle in and gauge the market before the mortgage is up for renewal.
More so, on a comparable basis, a 3-year variable rate will be lower than a similar 5-year variable rate mortgage.
A 5-year variable-rate mortgage is the most popular variable mortgage type in Canada.
Compared to three or six months, five years is enough time to settle in and start thinking of mortgage renewal stress.
However, the five-year term has more exposure to interest rate risk than the other variable-rate mortgage terms. There is a high probability that the interest rate will change before the end of the 5-year term, compared to a 3-year or 6-month term.
Effects of COVID (and why the variable rate won’t increase any time soon)
The world is experiencing COVID-19, which has dramatically affected financial lending institutions and borrowers. Canada has been involved too, and it is estimated that the economy will take several years to stabilize and grow again.
The government needs to plan a stimulus program in Canada by controlling the interest rates lenders charge for variable mortgage rates through the country’s central bank.
Presuming the government will keep the interest rate low will significantly help many borrowers in two ways.
First, it will reduce the amount they will be paying for their loan interest rates, and they will use what they save for other expenditures that may boost the economy.
Secondly, borrowing these types of loans will attract more borrowers to apply for them. The more people borrow and use the money for economic development, the more they will boost the economy.
Through the Central Bank of Canada, the government of Canada, to stimulate the economy, needs to keep the interest rate applied in Variable-rate Mortgages to encourage borrowing and boost the circulation of money in the economy as the country works toward reviving the economy after the COVID effect. This will stimulate economic growth.
Consumers need to take advantage of the low-interest rate on variable-rate mortgages to finance their projects as they recover and revamp their businesses.
In general, variable-rate mortgage loans tend to have lower rates than comparable fixed-rate mortgages because they are a riskier choice for consumers. Your cost of borrowing can significantly increase in a rising interest rate environment. This type of mortgage can be a better choice if you risk an unpredictable mortgage rate.
On the other hand, if the mortgage rate decreases during your term, your mortgage rate too will decrease, resulting in a higher portion of your payment assigned to pay down your principal mortgage loan.
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