Variable Rate vs. Adjustable Rate Mortgages
When considering mortgage options, the debate is usually fixed versus variable. However, did you know that all variable-rate mortgages aren’t created equal? There are actually two types of floating-rate mortgages in Canada: variable rate and adjustable rate. Both terms are used interchangeably; however, there are key differences between the two to be aware of.
Floating Rate Mortgage
This article will use the term “floating-rate mortgage” to refer to both variable rates and adjustable rates. With a floating rate mortgage, unlike a fixed rate, your mortgage rate isn’t fixed. Your mortgage rate can change during the term of your mortgage. This is usually a result of your mortgage lender changing its prime rate. And this almost always happens when the Bank of Canada raises interest rates.
The Bank of Canada doesn’t just decide to raise or lower interest rates on a whim. It has eight scheduled interest rate announcements a year. More often than not, it decides to leave interest rates the same. However, if the Bank of Canada changes interest rates, that’s when it can affect you if you have a floating rate mortgage.
With a variable rate mortgage, while the mortgage rate is floating, your mortgage payment is not. When interest rates change, typically, your mortgage payment will stay the same. The benefit to this is that it makes it easier from a budgeting standpoint. However, the downside to this is that unless you voluntarily start paying more, it will take you longer to pay off your mortgage and cost you more in interest.
With an adjustable-rate mortgage, similar to a variable rate, your mortgage rate is floating; however, unlike variable rate, your mortgage payment will change when interest rates change. If interest rates go up, your mortgage payment will go up. If interest rates go down, your mortgage payment will go down. It’s as simple as this.
There are pros and cons to adjustable-rate mortgages. The pro to this is that you’re forced to pay down your mortgage at the same pace you were originally supposed to. If the amortization period is 25 years, you’re scheduled to pay it off in that timeframe since your mortgage payments are adjusted as needed.
However, the downside is that it can be tough from a budgeting standpoint to handle the increases. The mortgage stress test helps soften the blow by making you qualify at a rate of 5.25 percent. But still, it can be tough to adjust to, especially if you have many other expenses, such as transportation, food and childcare.
Comparing the Two
Let’s say you have a $400,000 mortgage, amortized over 25 years, at an interest rate of 1.5 percent. Interest rates go up by 0.25 percent, meaning your mortgage rate goes up to 1.75 percent.
If you had a variable rate mortgage, your mortgage payment would remain the same at $1,599 per month. However, if you had an adjustable rate, your mortgage payment would go up to $1,646 per month. That’s a payment increase of $47 per month. And that’s only one increase. Imagine if rates went up three or four times in a year. That means your payment would increase by about $150 or $200 per month in total.
The Bottom Line
Before signing up for a floating rate mortgage, find out if it’s a variable rate or adjustable rate. Also find out what specifically happens when rates increase, as both terms are often used interchangeably. If you’re unsure at all, our mortgage experts can help you decide the mortgage type that’s right for you.