What is a Variable Rate?
It is an interest rate that fluctuates in accordance with the prevailing market prime rate during the mortgage term. The prime rate is linked to the Bank of Canada rate and is also commonly referred to as the “Overnight Rate.”
So, to put it in simple words, when BoC increases the rate, you pay more towards the Interest rather than your Principle. Does this mean your monthly payment will go up as well? With some banks, yes, but it is NOT always the case. Did you know that there are variable rate mortgages that allow you to have fixed payments regardless of the rate change?
Let's dive in into Variable Rates and see which one you currently have:
1- Capped Variable Rate Mortgage
(if your Lender: TD, HSBC, Manulife, Desjardins, Meridian, BMO, RBC, CIBC):
- Payment is static and does not fluctuate with Prime; When the rates go up, your mortgage payment remains the same, but your interest and principal ratio is changing.
- If rates rise, the amortization extends; Due to a lower principal payment, your mortgage amortization is extending. In the long run, you will be paying for a longer period, therefore, your mortgage will cost you more.
- If rates drop, the amortization period decreases; Due to a higher principal payment, your mortgage amortization is lowered in this scenario.
Strategy with C-VRM:
Even though your bank is allowing you to keep the same amount of payment with Capped Variable Mortgage (up until your prime $0), we highly recommend increasing the monthly payments in accordance with a BoC rate hike. It is important as you can increase the payments to maintain the same amortization schedule as laid out in the original loan agreement. It also helps you, as a mortgage holder, to avoid a situation where you might exceed the Trigger Rate, meaning your payment can no longer cover the Interest charged on the mortgage.
2-Adjustable Variable Rate Mortgage:
- Payments fluctuate with changes to Prime; Your bank will change the rate up/down with the fluctuation of a Prime Rate.
- With an Adjustable Variable Rate, you will never experience negative amortization; In this case, when your rate changes, you would never end up in a situation where your Principal Rate is at 0$.
- Payments may exceed affordability; With the interest rates going up to a certain point, this might hurt your budget as no one knows how far rates might go up.
Strategy with A-VRM:
It is always a good idea to increase your monthly payments for two reason: you are lowering your amortization and saving on the overall interest costs. Use a Lump-sum payment when you have such ability, as it might help in uncertain times like when the BoC increases interest rates.
We know you still might have questions, and for us, it is almost impossible to answer them all in this blog as everyone's situation is different. But our IK Team is here to help, don’t hesitate to email us at firstname.lastname@example.org, and our team will respond to you within a few business days.
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