What is an Adjustable-Rate Mortgage?

An ARM has floating payments to help keep your rate savings AND mortgage length intact.

Whereas the VRM, offered by some big banks, has static payments for a stable monthly budget, but may end up costing you more. Does that make the ARM a better choice?

Are you a THINK Financial client? Then you have an ARM with floating payments.
VRM static payments are offered by some big banks.

The ARM vs the VRM

Some homeowners choose the variable rate risk to potentially save more over (typically) higher fixed rates. But the payment type you choose can impact that overall savings advantage.

There are two types of variable rate mortgages:

  1. An Adjustable-Rate Mortgage (ARM) has a floating payment amount that rises and falls with changes in the prime rate. If the rate moves, the payment change usually happens at the end of a full payment period (usually the payment after the upcoming one).
  2. A Variable-Rate Mortgage (VRM) has static payments like a fixed-rate mortgage, but the interest portion rises and falls with changes in prime, pushing the 'principal' portion up or down. This product includes a Trigger Rate, which if reached, means that the payment no longer covers the interest portion.
The main differences between the ARM vs the VRM product:
Adjustable-Rate Mortgage (ARM) Variable-Rate Mortgage (VRM)
Payment Amount Changes with Prime Yes No
Interest and Principal Interest amount changes, principal amount paid stays on track Within payment amount, interest goes up or down affecting amount going to principal
Mortgage Length (Amortization) Unaffected by interest changes Gets longer or shorter depending on the amounts going to principal
Comes with a Trigger Rate/Point No Yes; if hit, mortgage length and balance can increase faster
Renewal Risk?* No. Mortgage length and balance on track to be paid off as scheduled Yes. If mortgage length and balance have increased, you'll pay a much higher payment (or a lump sum)
HOW YOU SAVE MORE** If rates go up, mortgage length and balance stay on track to NOT cost you more; if rates go down, you'll have extra monthly budget room If rates go down, more will go to your principal to pay off your mortgage faster
THE POTENTIAL COST If rates go up, increasing payments may strain your budget capacity If rates go up, you may experience 'payment shock' at renewal plus pay MORE interest if your mortgage length or balance has increased
*Not including current rate offered by lender
**Beyond any variable-rate advantage

Can the VRM derail your mortgage goals?

The VRM product provides budget certainty through static payments. But if rates go up and stay up during your term, it'll cost you more when it's time to renew. The higher the rate goes, the more interest you pay, with less going towards your principal. That lengthens your amortization, forcing the 'squeeze' into higher payments at renewal (unless you can provide a sufficient lump sum to bring things back in line).

During your term, if rates rise enough to hit and surpass your trigger rate and trigger point, both your amortization and mortgage balance will continue to increase. The lender will likely contact you to raise your payment or pay a lump sum well before your renewal.

So, the risk of a VRM is the potential for the static payments to derail your mortgage budget and goals, by forcing you into higher payments than expected at (or before) renewal. You'll also pay more interest overall, likely negating any variable-interest savings you were hoping for in the first place.

There is a flip side to this risk. If rates go down during your term, more of your payment will go towards your principal, which may help balance out previous increases or continue their pace to pay off your mortgage sooner.

The ARM may offer better long-term savings

Many in the mortgage industry, including True North Mortgage CEO Dan Eisner, feel that the ARM's floating payment is a better choice IF you can handle the potential for increasing payments. That's why it's the only variable-rate product offered by our in-house lender, THINK Financial. Dan looks at the bigger (mortgage) picture: "When rates go up, your payments are increasing gradually, allowing some time to adjust, versus the potential 'big payment shock' that may await you at renewal time with the VRM product." He adds, "Plus, you're more likely to keep your variable-rate savings intact, without the risk of increasing your interest costs through the static-payment vehicle."

A VRM can make the most sense when the spread with a fixed rate is wider.

"As the variable rate reaches where fixed rates are (at least another possible 0.75% increase by the end of the year), the VRM just doesn't serve the same purpose of locking in for a lower payment."
– Dashna Joya, long-time TNM broker

First of all, Dashna believes that the choice for her clients depends on their risk tolerance and the level of rate volatility we're seeing at any given time. She goes above and beyond to provide helpful advice based on her client's unique financial situation — and draws on her substantial experience with the higher prices and rate changes over the years in the Greater Toronto region.

But if we ask her about the VRM product: "In my opinion, VRM rates gave more cash flow stability when the payments were getting locked in at the 3.0% range — considering the wider spread with fixed rates at the time," she states. "As the spread narrows, it makes less sense to lock into a VRM's static payments rather than an ARM, especially at a time of rate hikes by the central bank."

However, for some clients who really prefer the (typically) lower variable rate, sometimes their budget monthly cash flow is their main concern — and they're willing to take on the VRM's risk for increasing their mortgage length and balance, while riding out the rate ups and downs.

Variable rates are higher. Can they still be a good choice?

Are you a variable-rate diehard but worried about rates going higher? Long-time True North Mortgage broker, Dashna Joya, feels an ARM is still a good choice over fixed rates for certain clients. "The ARM mortgage rates may be higher if you get a mortgage now," she states, "but you have the potential to take advantage of lower payments if rates come down in a year or two. A fixed rate doesn't offer that possibility."

"The rate and product you choose really depends on how well you can sleep at night with the changing nature of the variable rate."
– Dashna Joya, TNM broker

Compared to a fixed-rate product, both the ARM and VRM also offer significantly lower penalties for switching to a different product or lender (3-months interest vs IRD calculations), which is sometimes the deciding factor that tips a homeowner into a variable rate product.

Will variable rates go down soon? We're all crossing our fingers.

Dashna sees the light at the end of this latest high-inflation tunnel.

"As an experienced broker, I remind my clients that I don't have a crystal ball to know where rates are going to end up," she cautions with a smile. "However, if we see a trend of people tightening their budgets and spending, and inflation comes down enough, the central bank may stop their rate hikes sooner. And, if the Bank of Canada closes in on their 2.0% ideal inflation rate by the end of 2023 or early 2024 (it was 7.6% this past July 2022), they may begin to drop interest rates."

She states, "If they do drop and you have a VRM product locked in at today's higher variable rates, your payments won't decrease, BUT you'll start putting more towards your principal to help shorten your amortization as your term finishes out. If you have an ARM, then you'll get lower payments for some welcome budget relief."

The good news? Dashna reminds us that historically, variable rates tend to outperform fixed rates for mortgage interest savings. But, if you feel like it's time to make a change, your variable-rate product allows you more flexibility to switch to a fixed rate, or a lower variable-rate discount if one becomes available.

Have questions about your variable rate product?

It's important to know which type of variable product you have, or which one is the right choice for you. We have access to several lenders AND products, including those offered through our own lender, THINK Financial. Talk to us today if you have questions!

We're always here to run the numbers for you and provide options if you'd like a change, or if you need more ideas on how to save on your mortgage.

At True North Mortgage, our highly trained brokers have the tools and experience to help you make the right choice for your budget. Give us a shout anywhere you are in Canada — for 5-star mortgage advice.

Get the advice you need to sleep at night.