Variable Rate Mortgage

Definition

A variable rate mortgage is a type of mortgage in which the interest rate is not fixed and fluctuates in cycle with the current prime rate. Prime rate is the rate at which the commercial bank lends money to its customers. It is stated as prime plus or prime minus a percentage amount. Variable rate mortgage is usually lower than the fixed-rate mortgage.

A variable rate mortgage has fixed payments; however, changes in the interest rates affect how the payment is applied to the mortgage. If the interest rates go down, more of the payment goes to principal, and if the interest rates go up, more of the payment goes towards the interest. This interest is compounded monthly. Even though the variable interest rate may change monthly, the borrower’s monthly payments remain fixed.

A variable-rate mortgage can be a better option for an individual if:

  • An individual is comfortable with the possibility of fluctuating mortgage payments
  • An individual is comfortable to pay more in interest over the term of the mortgage
Explore Definition

Kept Simple

Let’s say an individual takes a variable rate mortgage loan to buy a house at YZ% of interest. He is required to pay the loan in 5 years. With variable rate mortgage loan, within those 5 years, the rate of interest – YZ% may fluctuate due to changes in the market rates.

How Does Apply to you

Suppose you opt to a Variable Rate Mortgage, to buy a house, for an 8-year term at 5%, the interest rate will not remain at 5% throughout the term of the mortgage. The interest rate would change or fluctuate depending on the changes in the market rates.

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