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A variable rate mortgage is also know as an adjustable rate mortgages (commonly called ARMs). These are flexible mortgages with interest rates and monthly payments that rise and fall with the economy. With an adjustable mortgage or variable mortgage, the borrower shares in the benefits and risks of having the mortgage tied to market changes. Because the borrower shares in the risk of rising rates, mortgage lenders are able to offer lower initial interest rates than on fixed rate mortgages. The interest rate on your mortgage is then adjusted periodically according to whatever market index you chose when selecting your ARM.
A variable rate mortagage or an adjustable-rate mortgage has an interest rate that changes based on changing market rates and economic trends. They usually offer an initial interest rate that is two to three percentage points lower than fixed-rate mortgages, but they don't offer the stability or assurance of a known mortgage payment in the years to come. If you don't expect to be in your home for many years a variable mortgage may be just what you need. Interest rate and monthly mortgage payments can change every six months, once a year, every three years, or every five years. For example, a one-year variable mortgage term has an adjustment period of one year, which means that the interest rate and monthly mortgage payment can change once a year. The frequency and dates of adjustments are established when you apply for your mortgage.
The interest rate on an variable mortgage or adjustable mortgage changes according to a financial index. You may choose an variable mortgage tied to any one of a variety of market indexes, such as CDs, T-Bills, or LIBOR rates. When your interest rate is up for adjustment, your mortgage lender will take the current rate of the index to which your mortgage is tied and add a margin, a certain set number of interest points laid out in your mortgage agreement, to determine your new rate. So, your interest rate and monthly mortgage payments could increase or decrease over the life of your mortgage, depending on the activities of the market.
Caps set forth in your mortgage agreement limit the amount by which the interest rate can increase at each adjustment. And ceilings, or lifetime mortgage caps, limit the total rate of increase over the life of the mortgage. So, if you have a typical one-year variable mortgage, your annual rate increase may be capped at 2%, which means that your interest rate can never increase by more than 2% over the previous year. Separately, your mortgage may have a lifetime rate cap of 6%. So, if you had an initial interest rate of 5%, the highest interest rate you could ever pay on your mortgage would be 11%. Caps protect you from drastic changes in interest rate, but do not guarantee you the stability of a fixed rate mortgage. With an variable mortgage, you exchange the possibility of lower interest rates for the possible risk of rising rates.
The ideal person for a variable mortgage may see the benefits in several ways. Adjustable Rate Mortgages (ARMs) offer a lower interest rate to start, so your monthly payments are generally lower. Every mortgage lender then adds a set margin to that index. Your mortgage payments could go up or down, depending on the economy and its resulting indicators. The index used, the margin added, and how often your rate is adjusted (usually every 1, 3, 5 or 7 years) can be different from mortgage lender to mortgage lender. Be sure to ask what they are. Variable rate mortgages usually come with initial interest rates that are 2-3 points lower than those on comparable fixed-rate mortgages. The lower initial interest rate can help you qualify more easily and afford the house you want to buy. You will most likely qualify for a larger mortgage with a variable rate than with a fixed rate mortgage.
You might also want to consider a variable rate mortgage if you plan to move in a few years, so you are not concerned about the possibility of rate and payment increases. If you plan to move within 5 years, a 5-year variable rate mortgage would even give you the advantages of a lower interest rate with none of the risks. And, even if you plan to live in your new home for longer, it might be safe to take the risks involved in a variable rate mortgage if you expect your income to increase enough to cover potential increases in payments, or if you expect rates to fall.
How often your interest rate adjusts is determined by the terms of the mortgage. You may choose a six-month variable rate mortgage, a one-year variable rate mortgage , a two-year variable rate mortgage, or some other term. There is usually an initial period of time during which the mortgage rate won't change. This might be anywhere from six months to several years. For example, a 5/1 year variable rate mortgage would mean the initial interest rate would stay the same for the first five years and then would adjust each year beginning with the sixth year. A 3/3 year variable rate mortgage would mean the initial interest rate would stay the same for the first three years and then would adjust every three years beginning with the fourth year.
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