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What You Need to Know About Variable Interest Rates

Author: Cody Rowe - Mortgage Broker | | Categories: personalized mortgage solutions , Bank of Canada , First Time Home Buyer , First-Time Buyer , Homebuyers Guide , Interest Rate , Mortgage Rates , Mortgage refinance , Mortgage Renewal , Mortgage Solutions , Self-Employed Mortgage , Vancouver , Variable Interest Rates , Victoria BC

If you're thinking about taking a variable interest rate, you're going to want to read this blog post.

With the prime rate dropping, variable interest rates are coming back into the fold, and a lot of homeowners and first-time buyers are beginning to inquire about taking on a variable interest rate instead of the fixed.

Now there is some risk involved in taking on a variable, but there's also some important features that we need to know about if we're going to consider a variable interest rate.

So let's dive in.

 

 

To begin, what a lot of Canadians don't know is that there's actually two types of variable interest rates.

There is what we call a standard or static variable interest rate, or an adjustable variable interest rate.

Static Variables

A static variable interest rate offers you a fixed payment during your term while still having a variable interest rate.

Some people might ask, how is this possible? How does my payment stay the same, but my interest rate can change?

The way it works is it actually addresses your amortization instead of your payment. So for example, if the prime lending rate drops, then that payment stays the same, but more of that payment is now going towards paying principal, and less of it is now going towards the interest that you're being paid because the rate is dropping.

But conversely, if the rates start to climb up, the payment stays the same but more of that payment is going towards interest, and less of it is going towards principal now.

So that leads into an important point about static variable interest rates, which is a trigger point. Now a trigger point is an exceptionally rare thing that can happen, but of course the pandemic was full of exceptions, and this is one of those examples where many people who had static variable interest rates found themselves hitting their trigger point.

A trigger point is when the payment that you're making no longer covers the interest that you're being charged. So when we saw the interest rates climb by 4% a few years ago, many people started to hit their trigger points, which is what caused many lenders to reach out to their clients to actually have to increase that static variable payment for them. So something to really be aware of if you're thinking about taking a static variable interest rate.

 

Adjustable Variables

The second type of variable interest rate that you can get is what's called an adjustable variable interest rate.

This is what most people think of when they think about a variable interest rate, and this is where if the prime rate drops, then your payment drops with it.

Conversely, if the prime rate starts to go up, well then your payment's going to start going up as well.

This one's a little bit easier to understand because it's directly affecting your day-to-day life, by directly affecting your mortgage payment, and it's not addressing things like amortization, which can be a little bit more confusing to understand.

Now regardless of whether you take on a static or an adjustable variable interest rate, one of the most important features that you'll want to be aware of if you're going to take on a variable rate is your conversion options.

Now in situations where we see the rates starting to drop like we're seeing right now, a lot of people are opting to want to go on that ride and see how low that rate can get for them.

But if we start to see the rates starting to climb up in the next couple of years - which is a very good possibility because remember how quickly they dropped and then how quickly they rose during the pandemic – it’s going to be important to remember that you're going to have (or you should have) a conversion option in your variable interest rate that allows you to convert your variable into a locked in fixed rate that's permanent for the term of the mortgage.

So if we start to see rates rising again, like I said, this is an amazing feature that you can have built in so that you can protect yourself against risk down the road.

So there’s some important info on variable interest rates to help you navigate, but if you have any questions about your own personal situation and whether a variable interest rate would be good for you, feel free to schedule a call, or send us an email.  

Article written by:

Cody Rowe

Senior Mortgage Consultant

Dominion Lending Centres

Modern Mortgage Group

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