Variable Rate Mortgage

A variable rate mortgage is a type of home loan where the interest rate is not fixed but can change based on fluctuations in a corresponding financial index that is tied to the loan. This option is commonly chosen by property owners who are prepared to take on the risk of interest rate changes in exchange for potentially lower rates initially. Understanding how variable rates can affect mortgage payments is crucial for effective financial planning in the management of rental properties.

Variable rate mortgage definition

‍A variable rate mortgage, also known as an adjustable-rate mortgage (ARM), has an interest rate that may increase or decrease at certain points during the life of the loan. These changes are tied to a specific benchmark or index, such as the prime rate or LIBOR, reflecting broader economic conditions.

Factors influencing variable rate mortgages

• Benchmark Rates: The initial setting and subsequent adjustments of the mortgage rate are often linked to a well-known index or benchmark.
• Loan Terms: Specifics of the mortgage agreement can determine how often and by how much the interest rate can change.
• Market Conditions: Economic factors that influence the indices to which variable rates are tied will affect the interest rate and, consequently, the mortgage payments.

Benefits of variable rate mortgages

• Lower Initial Rates: Variable rate mortgages often start with lower interest rates compared to fixed-rate mortgages, making them attractive in the short term.
• Flexibility: These loans can be beneficial if interest rates decrease over time, potentially lowering payments.
• Adaptability: Suitable for owners who plan to hold properties only for a short term or expect rates to drop in the future.

Real-world example

‍Consider a rental property owner who chooses a variable rate mortgage with an initial rate that is lower than the fixed-rate options available. If interest rates remain stable or decline, the owner benefits from lower payments, increasing cash flow which can be reinvested into the property or used to cover other expenses. However, the owner must also be prepared for potential rate increases, which could raise mortgage payments.

Final words

‍Variable rate mortgages offer potential benefits but come with inherent risks due to their dependence on fluctuating interest rates. Property owners considering this type of mortgage must assess their ability to handle potential increases in payments and decide whether the risk is acceptable given their financial situation and investment strategy.