Variable Rate Mortgages
A mortgage is
a loan you can obtain from a bank, building society or mortgage
lender, which is then used to pay for a home and any land it
sits on. The house and the land serve as collateral for the
loan - which basically means if you don’t make your payments
on the loan the lender can then take the home away from you
(repossess) to cover your missed payments. Because mortgages
are such large loans – probably the biggest financial
commitment most people will ever make – they are repaid
over long periods of time, usually between 15-30 years. Mortgage
repayments are usually made up of two factors: ‘the principle’,
which is the amount you borrow, and ‘interest’,
which is the amount the lender charges you for using their money
and which may vary depending on the current market. The payments
made during the initial years of a mortgage consist primarily
of interest payments, and later payments will contain more principle.
Some payments may also include buildings insurance as most lenders
will not give you a mortgage unless they know their investment
will be protected.
There are a number of different products available on the
market today but mortgages generally fall into two categories:
Variable Rate Mortgages (also referred to as adjustable rate
mortgages or ARMs) and Fixed Rate Mortgages. The variable
rate mortgage was developed during a time of high interest
rates that kept many people out of the housing market. The
variable rate mortgage offers lower initial rates by sharing
the future risk of higher rates between borrowers and lenders.
The interest rate for a variable rate mortgage varies over
time. The initial interest rate on a variable rate mortgage
is set below the market rate on a comparable fixed rate loan,
and the rate rises as time goes on. If the variable rate mortgage
is held long enough, the interest rate will surpass the going
rate for fixed rate loans. The starting interest rate with
this type of mortgage is lower than that of a fixed rate mortgage
however this interest rate will rise and fall according to
the market trends. This means you can benefit from falls in
the interest rate but you are also subject to rises in repayments
as the interest rates go up. Because the initial interest
rate is low, a variable rate mortgage may also enable you
to qualify for a larger loan amount because lenders sometimes
make this decision on the basis of your current income and
the anticipated monthly repayments for the first year or two.
Variable rate mortgages are attractive because they offer
low initial payments, enable the borrower to qualify for a
larger loan and in a falling interest rate environment, allow
the borrower to enjoy lower interest rates (and hence lower
mortgage payments) without the need to refinance. The downside
to a variable rate mortgage is that your monthly repayments
may change frequently over the life of the loan. If you do
take on a larger loan you also take on extra financial strain
when interest rates rise. Because payments and interest rates
can increase, either steadily or irregularly, homebuyers considering
this type of mortgage need to have the income to keep up with
all the possible rate and/or payment changes.
A variable rate mortgage may be an excellent choice if low
payments in the near term are your primary requirement or
if you don’t plan to live in the property long enough
for interest rates to rise.
If interest rates are high and expected to fall, a variable
rate mortgage will ensure that you enjoy lower interest rates
without the need to refinance. If interest rates are climbing
or a steady, predictable payment is important to you, a fixed
rate mortgage may be the way to go.
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