Understanding the Difference Between Variable Rate Mortgages (VRM) and Adjustable-Rate Mortgages
When it comes to choosing the right mortgage, many Alberta homebuyers wonder about the difference between a Variable Rate Mortgage (VRM) and an Adjustable-Rate Mortgage (ARM). While both types offer interest rates that can fluctuate over time, they function differently, impacting your monthly payments and financial planning in unique ways. Here’s a breakdown of VRMs and ARMs to help you make an informed choice.
What is a Variable Rate Mortgage (VRM)?
A Variable Rate Mortgage (VRM) has an interest rate that fluctuates based on the lender’s prime rate. However, what makes VRMs unique is that your monthly mortgage payment stays the same even if interest rates change. With a VRM, changes in the prime rate will adjust the portion of each payment that goes toward interest versus principal. When rates go up, a larger part of your payment covers interest, and when rates go down, more goes toward reducing the principal balance.
Key Features of a VRM:
Consistent Monthly Payments: Unlike adjustable-rate mortgages, VRMs keep your monthly payments consistent.
Impact of Prime Rate Changes: Although your payment amount stays the same, the allocation between principal and interest fluctuates.
Interest Rate Cap: Some lenders set a cap or limit to how high your rate can go, offering protection in times of rapidly increasing rates.
Benefits of a VRM:
Predictable Payments: You’ll know exactly what your payment amount will be each month, which can help with budgeting.
Potential to Pay Down Principal Faster: When rates are low, a larger portion of your payment goes toward the principal, reducing the balance faster.
Considerations with a VRM:
Risk of Payment Shock: If interest rates rise significantly, the portion going toward interest increases, which may affect how quickly you pay down your mortgage balance.
Possible Conversion Option: Many lenders allow VRM holders to convert to a fixed rate if rates begin rising.
What is an Adjustable-Rate Mortgage (ARM)?
An Adjustable-Rate Mortgage (ARM), sometimes known as a floating rate mortgage, differs from a VRM in that both the interest rate and the monthly payment amount fluctuate. When the prime rate changes, so do your monthly payments. With an ARM, you may see both your payment and interest allocation adjust in response to market rates.
Key Features of an ARM:
Flexible Monthly Payments: Payments adjust periodically in line with changes in the prime rate.
Interest Rate Changes: In rising rate environments, payments increase, while they decrease in a falling rate environment.
No Cap on Payment Changes: ARMs often do not have a cap, meaning payments can continue to rise if rates increase.
Benefits of an ARM:
Potential Savings with Low Rates: When interest rates are low, both your interest rate and payment amount decrease, offering potential cost savings.
Adjusts to Market Conditions: ARMs adapt to current rates, which can be beneficial in a declining rate environment.
Considerations with an ARM:
Unpredictable Payments: Payments can fluctuate, making it challenging to budget long-term.
Higher Payments in Rising Rate Markets: If rates increase significantly, your payments will also rise, potentially impacting affordability.
Which Mortgage Option is Best for You?
Deciding between a VRM and an ARM depends on your financial goals and tolerance for risk. Here are some scenarios where each might be beneficial:
Choose a VRM If…
You value consistent payments and want to stick to a stable monthly budget.
You’re comfortable with the idea of your interest allocation fluctuating but prefer your payment amount to stay the same.
You want the option to switch to a fixed-rate mortgage if rates increase significantly.
Choose an ARM If…
You can tolerate some unpredictability in your monthly payments.
You believe interest rates may decrease and want to take advantage of potentially lower payments.
You’re prepared to handle rising payments if interest rates increase.
The Bottom Line: Making an Informed Choice in Alberta
In Alberta’s dynamic mortgage market, it’s essential to understand how VRMs and ARMs differ to select the mortgage that best suits your needs. A VRM provides stable monthly payments but with variable interest allocation, making it a strong choice for those who prefer predictability. An ARM adjusts both your payment and interest rate with market conditions, which may appeal to those looking to capitalize on rate fluctuations but who are comfortable with payment changes.
If you’re weighing the choice between a VRM and an ARM, speaking with a mortgage broker can help clarify the best path forward for your financial goals.
Ready to explore mortgage options in Alberta? Contact us today to discuss whether a VRM or ARM fits your home-buying strategy!
