Adjusted Versus Variable

As you may know from reading and following my posts over the last year, variable interest rates fluctuate based on the prime lending rate and the Bank of Canada's overnight rate. Unlike fixed interest rates, which stay static for the entire term of a mortgage, variable interest rates can change. There are two different types of variable interest rates and they both move and fluctuate in different ways:

Adjustable

This type of interest rates is rather unique. With any mortgage, your monthly mortgage payment goes towards paying off two things, principle and interest. The principle is what you borrowed to buy your home, interest is what you are being charged by the lender for borrowing the money. In the beginning, the portion of your payments dedicated to the principle is much lower than the portion dedicated to the interest you owe. The more payments you make as time goes on, the bigger the principle portion grows and the smaller the interest portion becomes.

However, when the prime lending rate moves up or down, instead of having your overall payment amount increase or decrease, the principle and interest portions inside of an adjustable rate change. If the prime lending rate goes down, more of your monthly payment will go towards principle rather than interest. The other way, if the prime lending rate goes up, the portion going towards paying off the interest portion of your monthly payments will go up and the portion for the principle amount will decrease.

Variable

With a variable interest rate, the overall monthly payments and dollar amount will change when ever the prime lending rate goes up or down. When the prime lending rate goes up, the interest being charged to you will increase but the percentage going to principle and interest will remain the same because the total payment increased. Likewise, when the prime lending rate goes down, your monthly payments will decrease but the percentage going towards principle and interest will remain the same because it will still take you the same amount of time to pay off the entire mortgage as before. Unlike an adjustable one where the total payment stays the same but the length of time to pay off the entire mortgage may of been altered.

Example:

Variable Rate Mortgage or VRM: P-.55 (Prime lending rate minus 0.55%).

Adjustable Rate Mortgage or ARM: P-.55 (prime lending rate minus 0.55%).

Lets say the prime lending rate is currently 3.95 (which it is). These rates would be as follows:

VRM: 3.4% ARM: 3.4%

Lets say now the prime lending rate moved to 4.20%. These rates would now be:

VRM: 3.65%

ARM: 3.65%

The VRM mortgages will still be amortized over 25 years or however long is remaining. The total monthly amount would change but the breakdown of principle and interest portions remain unchanged. The ARM mortgage will not have a payment increase, however, the length of time it will take for that mortgage to be paid off will increase and the proportional breakdown of principle and interest will now be different.

Small variations but very different impact on the results. Make sure you know which type of variable interest rate will work best for you if you decide to avoid fixed interest rates. Usually, most lenders will allow ARM mortgage clients to adjust their monthly payments accordingly to keep their amortization schedule on track, something you need to confirm before choosing lenders. If you have any questions about variable rate or adjustable rate mortgages, please feel free to contact me!

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