Interest Rate Type (Fixed, Variable)



Fixed Rate Mortgage - FRM


The interest rate and the payment amount do not change for the entire term. Allows to choose an open or closed term.

The most common repayment plan in Canada today. It brings you the peace of mind to stay on budget - you know your payments will stay the same for the duration of the term. It is simple and easy to understand. Suitable for borrowers who are "risk sensitive" (fluctuations in rates cause them stress).

Benefits: Your mortgage rates won't increase. You know what the payment is throughout the term and can budget accordingly. That may be important for first time home buyers who may be used to renting and paying a fixed amount for shelter every month. In addition you don't have to keep a close watch on rates (as in the case of a variable rate mortgage).

Considerations: Higher rate. You may not save as much interest as possible when compared to the variable rate option.

Variable Rate Mortgage - VRM (a.k.a. Adjustable Rate Mortgage - ARM)


The interest rate portion of the payment fluctuates over time according to changes in the overall financial market.

Most VRMs offer the flexibility of allowing you to switch to a fixed rate plan through the same lender without penalty. This provides you with the comfort of being able to switch if the variable rate begins to rise.

This type of mortgage tends to offer the greatest savings possible since the rate of interest charged tends to be the lowest among mortgage products offered in the market today.

It can save you money, but it can also have the reverse effect if rates rise. You must be financially sophisticated enough to keep a close watch on rates and make the decision to switch to a fixed rate product if and when the situation warrants it. Suitable if you are not "risk sensitive" (fluctuations in rates do not cause you stress): if you are going to lose sleep at night worrying about an increase in interest rate, maybe it is not for you.

VRMs come in 2 flavours - "Constant Payment Amount" and "Changing Payment Amount".

Constant Payment Amount:

Your periodic payment amount always stays the same, but the amount that goes to pay either the principal or the interest changes as the interest rate changes. When interest rates are lower, more of the payment is allocated towards the principal balance. Likewise, when rates are higher, more of the payment is devoted to the interest. For example, one month 80% of your payment goes towards the balance and 20% - towards the interest, and the next month - 77% towards the balance and 23% towards the interest. So, only the "limit mark" between the principal portion and the interest portion of the payment amount fluctuates, while the size of the payment doesn't change (except of very specific circumstances).

Benefits: If the rate drops, that decreases the contracted amortization period (and interest rate being paid overall: the shorter amortization, the less interest paid during mortgage life).

Considerations: If the rate goes up, that increases the contracted amortization period (and interest rate being paid overall: the longer amortization, the more interest paid during mortgage life).

Changing Payment Amount:

The whole periodic payment amount (NOT the "limit mark" between the portions) fluctuates: when the interest rate changes, that accordingly affects the payment amount (not affecting the amount, allocated towards the principal balance).

Benefits: If the rate drops, that decreases the payment amount, improving your cash flow.

Considerations: If the rate goes up, that increases the payment amount, impacting your cash flow.

Home Equity Line of Credit (HELOC)


It's a Line of Credit secured by a real property. A Line of Credit (LOC) is an amount of credit made available to a borrower but not advanced on closing. It is a debt with a credit limit that allows the borrower to withdraw funds up to that credit limit. For example, if a borrower had a $300,000 LOC he or she would be able to use these funds whenever he or she wished. However, payments are only made on the outstanding balance of the LOC.

Repayments are based on a percentage of the outstanding balance and interest is charged only on the amount of the credit limit that is actually used. A typical HELOC has monthly payments of interest only based on a variable rate. The borrower can make payments as small as the interest only or as large as he or she wishes.

Benefits: You can borrow funds as necessary and make repayments that fit your budget.

Considerations: Same as in VRM. In addition, the amount that the property is encumbered by (i.e. the amount of debt registered on title) remains the same with the course of time - that is the amount available to a borrower (but not necessarily borrowed). For example, if the outstanding balance of the mortgage (i.e. the actual debt) is 50K, but the available amount is 300K, then the debt of 300K is registered on title all the time - until the mortgage is paid off in full. That makes sense because the homeowner can borrow additional 250K at any moment.



More information can be found in the site of Financial Consumer Agency of Canada: Understanding variable interest rate mortgages.


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