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Save Money With A Variable Rate Mortgage
Everybody's heard of Variable Rate Mortgages (VRMs)-but very few people understand what they are, how they work and so people tend to shy away from one of the best products available to help them pay down their mortgage faster. The greatest difference between VRMs and fixed rate mortgages is how the rates are set. VRM rates are set based on the Bank of Canada rate. The chartered banks add a slight premium to the Bank Rate to establish the Prime Rate. This is what most lenders use to price their various VRM products. In our system, the Bank of Canada uses its bank rate to control inflation in the economy. When little or no inflation is present, as is the case right now, this rate tends to be set at very low levels and is relatively stable.
The fixed rates, on the other hand, are set based on the yield in the bond market. The bond yields are very volatile and tend to fluctuate, often due to political and economic conditions. This volatility makes it impossible to gauge what fixed rates will do, even in the short-term.
Here's how the smart consumer wins by taking a VRM over a fixed rate product. Right now, you can get a discounted VRM with a rate, around 4.00%. Conversely, the discounted fixed rate for a 5 year mortgage is around 5.45 %. The smart consumer takes the VRM with the low rate but makes the payments as if the mortgage is at the higher, fixed rate. The difference between the minimum, required payment, (calculated @ 4.00%) and the payment being made (calculated @ 5.45%), is additional monies that are going directly to reducing the principal. Even if the Prime Rate starts to increase, it will probably take a long time before it reaches a level close to the fixed rate currently available.
For added comfort of the borrower, the VRM has an option to lock-in at any time to a fixed rate, by simply informing the lender. But don't be too hasty in doing just that. I have known many individuals who got nervous at the first sign of a Bank Rate increase, called their lender, locked in the rate and regretted it for the next five years. As a matter of fact, a quick analysis shows, that if you took out a 5 year, VRM anytime between January 1990 and now, set your payments at the higher rate as I've indicated above, your outstanding mortgage balance would be lower than if you took a 5 year, fixed rate, mortgage.
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