Variable Rate Mortgages

Is a variable rate mortgage is right for you!

A variable rate mortgage is the second most popular home loan. It is second to the fixed-rate mortgage home loan. A variable rate mortgage (also called an adjustable rate mortgage or a flexible-rate mortgage) is a mortgage with an interest rate that increases or decreases over the period of the loan according to predetermined market conditions.

Buying your own home may be the largest financial undertaking in your life time. By financing your home, you have a long term financial commitment to a mortgage lender. Most mortgage loan terms are from 15 to 30 years. Thus, it is of paramount importance that you select the right loan type. You must select a loan type that suits your financial situation.

A variable rate mortgage is unlike a fixed rate mortgage because the interest rate changes over the term of the loan. The interest on a variable-rate loan is recomputed from time to time according to a certain financial index. This index tends to rise and fall as interest rates change in the economy. When the interest rate is changed, the monthly payment will change accordingly. However, most variable-rate mortgages are set up to be adjusted once a year on the anniversary date of the origination of the loan (the date the loan was finalized).

If the index has gone up on the anniversary date of the variable rate mortgage, the lender will raise the interest rate applied to the loan. If the index has fallen on the anniversary date of the loan, the lender will adjust the interest rate downward. Borrowers of variable rate loans are often protected from large changes in payments through preset limits or caps placed on the amount of interest that can be charged. For example, if the loan amount comes with a limit of 10%, you can never be charged more than a 10% interest rate over the life of the loan.

A major advantage of a variable rate mortgages is that they are offered at a much lower interest rate than fixed-rate mortgages. Because of the initial lower interest rates, borrowers opt for a variable rate mortgage over a fixed-rate mortgage. Another advantage of a variable rate mortgage is that you get automatic free refinancing when interest rates fall.

Selecting a variable rate mortgage is not as simple as selecting a fixed-rate mortgage. A variable rate mortgage is riskier and more unpredictable than a fixed-rate mortgage because of the fluctuations in interest rates over the life of the loan.

If it is unlikely that you will have a significant increase in your earnings during the life of a variable rate loan, you should steer away from this loan type. You may not be able to meet the monthly loan payments if interest rates increase substantially. If you default the loan, then your home is at risk for foreclosure.

A variable rate loan makes it difficult for you to plan your budget because you don't know what the interest rate will be from year to year. An important factor in deciding whether to select a variable rate mortgage or a fixed-rate mortgage is the volatility of interest rates. In a period of volatility, you would want the predictability of a fixed-rate mortgage.

The interest rate never changes over the life of a fixed-rate loan. With a fixed-rate loan, your interest and monthly payments will be the same over the life of the loan. Thus, you will have to decide whether or not your financial situation will allow you to select a variable rate loan over a fixed-rate loan.

Most types of mortgages can have escrow accounts. The escrow accounts are for the purpose of paying property taxes and insurance premiums. The monthly escrow payments are subject to changes due to increases or decreases in the property taxes and/or insurance premiums. However, these monthly escrow payment changes are independent of the interest rate changes associated with a variable rate mortgage.

In addition to being charged interest, you are also charged fees and points with variable rate mortgages. If you are not sure what loan type best suits your financial situation, we have qualified financial counselors to assist you in selecting the mortgage loan type that is commensurate with your financial situation.

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