Can variable-rate fixed payments derail your mortgage goals?
The VRM product's fixed payments can provide budget certainty. But the higher the rate goes, the more interest you pay, with less going towards your principal. That lengthens your amortization, which can quickly extend beyond your original loan time — a state called negative amortization.
If rates go up and stay up during your term, that negative amortization state means you may be in for payment shock when it's time to renew.
What is payment shock?
It means renewing into a much higher payment than before, which can occur due to a higher market rate or a suddenly higher mortgage balance. If your amortization has increased during your term, your bank will reduce it to the correct amount when you renew your mortgage (the original term minus the previous terms served) — which increases the balance to be paid off in that time, resulting in a higher monthly payment.
What happens if you hit your trigger rate?
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, but it may not be enough to stop your amortization from increasing.
Yes, a VRM risks derailing your mortgage goals.
During a strong upward prime rate trend, you may be forced into much 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 enough during your term, more of your payment will go toward your principal, which can help balance out previous increases or continue at that lower pace to pay off your mortgage sooner.
The ARM may offer better long-term savings.
Better overall?
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.
Plus, you're more likely to keep your variable-rate savings intact, without the risk of increasing your interest costs through the fixed-payment vehicle."
Better for your budget if variable rates go down.
With floating payments, if and when variable rates finally start to drop, your payments will adjust downward with each decline, resulting in a lower mortgage payment and some welcome budget relief.
With fixed payments, you likely won't be able to change your payment amount with the lender. And even if variable rates have dropped — if you still have negative amortization by the time you renew, you'll face higher payments.
You'll pay a lower penalty if you need to break — regardless of your variable-rate payment type.
Compared to a fixed-rate mortgage, both the ARM and VRM 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.
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.
