23 Jan What does a variable rate mortgage look like?
The variable rate mortgage and the fixed rate mortgage are very different in terms of how they are funded. Fixed mortgages are bonds purchased by a mortgage lender, sold as a mortgage to a home buyer and then re-sold as a income based security back to the financial market. Variable mortgage rate products are based on the prime lending rate. With a variable rate mortgage, the interest rate adjusts periodically. So if prime goes up then your rate goes up. There is a discount component to the variable rate mortgage. It is impacted by the value of the dollar relative to other currencies and it regulates the amount of money that is being bought by the chartered banks from the federal reserve to service Canadian borrower’s needs. The strength of the economy and the inflation rate determines the level the prime rate is held at when the Governors of the Bank of Canada meet every few months.
What does this look like? When rates on variable interest rate mortgages decrease, more of your regular payment is applied to your principal. Additionally if rates increase, more of your payment will go toward the interest. On the other hand, the fixed mortgage rate is based on bond futures. It is a fixed contract where your payment does not increase for the duration of the term. Often times we hear the term “locked in” as it is exactly what it happens to a given rate, which is protected from rate fluctuations or increases.
In other words, the appeal of variable mortgages is that the interest rate is typically lower than that of fixed rate mortgage products. However, the main challenge is the risk involved. Without warning, interest rates could increase or decrease.