Variable Rate Mortgage (VRM)
The following article will cover all aspects of a Variable Rate Mortgage including: What is a Variable Rate Mortgage, How does a Variable Rate Mortgage work, What are the key factors of a Variable Rate Mortgage and the benefits of a Variable Rate Mortgage.
What is the definition of a Variable Rate Mortgage?
A variable rate mortgage is a house loan with an interest rate that isn’t set in stone. Instead, interest payments will be adjusted at a rate that is higher than a certain benchmark or reference rate, such as the Prime Rate plus 2 percentage points. Over the life of a mortgage loan, lenders can give borrowers variable rate interest. They can also provide a hybrid adjustable-rate mortgage (ARM), which has a fixed rate for the first few years and then a variable rate that resets on a regular basis.
How does a Variable Rate Mortgage work?
A variable rate mortgage varies from a fixed rate mortgage in that rates are structured as floating rather than fixed for a part of the loan’s term. 2 Lenders provide a variety of variable rate and adjustable rate mortgage loan packages, each with its own variable rate structure.
Lenders can often provide borrowers completely amortizing or non-amortizing loans with various variable rate interest arrangements. Borrowers who expect interest rates will reduce over time choose variable rate loans. Borrowers can benefit from lower rates without refinancing in a falling rate environment, since their interest rates fall in lockstep with the market rate.
Borrowers on full-term variable rate loans will pay variable rate interest for the duration of the loan. The borrower’s interest rate on a variable rate loan is determined by the indexing rate plus any needed margin. The loan’s interest rate may change at any point throughout the term of the loan.
What are the key factors of a Variable Rate Mortgage?
- Rather of having a set interest rate throughout the loan’s life, a variable rate mortgage uses a floating rate for part or all of it.
- Most variable rates use an index rate, such as the Prime Rate or the Fed Funds Rate, and then add a lending margin on top of that.
- An adjustable rate mortgage, or ARM, is the most prevalent type, with an initial fixed rate term of a few years followed by regular adjustable rates for the remainder of the loan.
What are the benefits of a Variable Rate Mortgage?
Variable rate mortgages provide the advantage of having lower starting payments than fixed-rate loans, as well as reduced payments as interest rates fall. Variable rates are built around an indexed rate with a variable rate margin added on top. If a borrower is charged a variable rate, the underwriting process will assign them a margin. The fully indexed rate, which is based on the indexed rate plus margin, will be included in most variable rate mortgages.
The disadvantage is that if interest rates rise, mortgage payments may climb as well. As loan rates rise, homeowners may find themselves trapped in an increasingly costly property.
Last Updated on 06/02/2022 by Mark Verhoeven
Financial Consultant and Author