Selecting the mortgage term as well as the precise mortgage fee is no doubt a great risk in the present day business of securing loan by a property. Having made a choice, whether advantageous or disadvantageous, the debtor has to abide by it till the loan is repaid. In this backdrop, it may be said that variable or amenable rate mortgages better known as VRMs best suits those who always willing to gamble or take risks. In fact, the VRMs allure people who love to live precariously, invest their money where their mouth is and believe that the interest charges will plummet to their benefit. Although VRMs have plenty of downsides, the fact still remains that the variable rate mortgages are still the most feasible substitute in specific situations.
Unlike in the case of variable rate mortgages (VRMs), the fees or interest charges are fixed and not changeable in the instance of a fixed rate mortgage. The term of a variable rate mortgage may be for any period of time ranging from one to five years, but the interest charges are amenable and may fluctuate as frequently as once a month subject to the price of the capital in the market. In this case, the debtor is faced with the perils of the oscillating interest rate and is required to pay more if the rate is higher that what it was when the loan was sanctioned. In simple terms, the borrower has to pay a monthly interest on the loan on the basis of the prevailing market rate. Looking back, it can be deduced that the concept of variable rate mortgage originated during the time when the interest charges were far above the ground and the lenders found it difficult to appropriately correspond investment resources to the amount they were giving out as mortgage loans. In reality, variable rate mortgages ensure that the lender receives the interest coverage required by him or her to carry on functioning.
Interestingly, similar to other mortgages or the business of securing loan by property, the explicit expression of variable rate mortgage also depends on the lender. There are several parallels between variable rate mortgage and other varieties of the business of securing loans against property as the majority of the VRMs are completely open or open with a predetermined payment or fine. As the variable rate mortgages stipulate that the interest fees are dependent on the prevailing charges at the marketplace, the creditor normally does face any monetary losses. This is owing to the fact that the interest paid in advance may be lent out again at the prevailing charges.
At the same time, variable rate mortgages or VRMs also have provisions for more extensive periods. As the accrual fees change recurrently throughout the mortgage period, the corresponding rule is fulfilled at all times. If one follows this as a base, it is possible to enter into an agreement for 25-year mortgage term, but the creditors usually do not like a variable rate mortgage extend the period beyond five years. It is important to note that since the interest is worked out according to the prevailing market rates every month, in the instance of variable rate mortgages, there is no scope of paying the charges twice a year or biannually. Moreover, it must be mentioned here that the interest fees in the case of variable rate mortgages is normally above what is usual or than that is paid for a fixed or flat rate mortgages. In this instance, it is important to evaluate similar items, i.e. grapes and grapes and not grapes and apples. If you work out an interest rate that is 13 per cent per month, it actually means you are paying much more - 13.357 per cent biannually!
Having said this, you will be amazed to learn that weighed against a lot of typical mortgages, the interest charges of variable rate mortgages (VRMs) are more often than not less. It may be noted here that all conventional mortgages include a specific clause or 'inflation influence' that requires the debtor to pay extra interest fees in addition to the cost on the amount taken on loan during times of price rise. Thus, in the instance of an inflation or when an imminent price escalation is apprehended, lenders or the mortgagees are not only entitled to add an extra charge to the cost of the money they have lent out, but also apply this provision to cover the risks of inflation, which are likely to move up the cost of the loan amount in such circumstances. However, if one opts for a variable rate mortgage product, the borrower does not have to face the consequences of such a clause in the agreement. This is because a variable rate mortgage clearly stipulates that the interest rate on the borrowed amount will always depend on the prevailing market rate at the time of paying the fees. Such an arrangement not only takes care of the possibility of inflation and the cost of the loan amount, but also does not require the borrower to make any additional payments in the anticipation of a price rise in future.
As mentioned earlier, though the conventional mortgages and variable rate mortgages are basically different forms of business for securing loan by a property, they have many similarities too. For instance, in both these types of mortgage products, the preliminary imbursement on the mortgage and the interest are fixed in the same manner and the interest charges are worked on a month-long basis. For instance, if a mortgage worth $50,000 is to be repaid over a period of 25 years at the present accrual charge of 15 per cent, the debtor is required to make a payment of $640.42 to the lender every month. In this situation, the interest charge is amenable, but the amount to be paid every month remains fixed. There are many creditors who often permit a gradual increase in the payment system provided this was agreed upon right at the beginning of entering into the mortgage deal.
Variable rate mortgages also comprise a unique feature. In the case of conventional mortgages, the borrower is required to pay a lesser amount every month when the interest rates drop in the market. Contrarily, in this instance of variable rate mortgages, the debtor is required to pay additional money in such situations and the extra amount goes towards reducing the unpaid principal amount. In fact, the additional money paid by the debtor is a forestallment that lowers the interest charges as well as the repayment of the loan amount. On the other hand, when the interest goes up in the market during the mortgage term, the borrower is required to make a monthly payment that is lesser than what is required to repay (amortize) the mortgage loan over 25 years.
In the case of a variable rate mortgage product, much of the monthly payment made by the borrower is adjusted against the interest charges on the loan. This is one of the major drawbacks of the variable rate mortgages as when the interest charges escalate vigorously in the market, the monthly payment may not be adequate to contain the interest amount accrued for a particular month. In such a situation, the due interest is combined with the unpaid principal. Such a provision is known as 'negative amortization' and when this happens; the debtor may perhaps ultimately land up owing more money to the creditor than the amount at the beginning of the mortgage. As such a provision also reduces the home owner's equity or stake on his or her property, they may be required to make a greater imbursement or make a single large payment that may be used either to adjust against the unpaid principal amount or clear the debt in totality.
Here is an example to understand the issue better. Supposing Tom and Elisa are contemplating to exit from the variable rate mortgage as mentioned above and would like to find out the consequences if the interest rate goes up or falls by one per cent during the very first year of availing the mortgage loan with the payment required to be made every month being $640.42.
| Amount Of Interest Paid | Amount Principal Reduced By | Principal After One Year | |
| At 15% (no change) | $7,486.73 | $198.31 | $49,801.69 |
| At 14% (rate down 1%) | $6,954.29 | $730.75 | $49,269.25 |
| At 16% (rate up 1%) | $7,685.04 | ($339.16) | $50,339.16 |
As mentioned earlier, if the interest rates in the market went up, the borrower was required to pay a lesser amount every month that what was agreed upon at the outset of the mortgage loan. So, when the interest fee goes up one per cent to 16 per cent, all the money paid by the debtor that month was utilized in adjusting the interest amount due for that month. Moreover, there was deficit of $339.16 and this amount was combined with the unpaid principal. So, ultimately the debtor has to pay much more money than what was at the beginning of the loan. And this is a big risk on the part of the borrower and something that requires a lot of guts to opt for a variable rate mortgage!
Variable rate mortgages comprise a number of other issues and they need to be studied carefully. Unlike in conventional mortgages, in most instances of VRM, the creditors don't sanction loans equivalent to 75 per cent of the property's appraisal value. Normally, the lenders finance a maximum of 66 to 70 per cent of the evaluation price of a property keeping in view that if the accrual charges escalate, it would result to an higher unpaid principal amount and diminish the equity share of the borrower on his or her property. In fact, a person should have a high income or the percentage of Gross Debt Service and Total Debt Service is essential if one desires to meet the criteria for obtaining a variable rate mortgage product.
At the same time, the majority of the creditors only offer variable rate mortgage as a first mortgage with the condition that if there is any second mortgagee, he or she should accept that the loan amount sanctioned in the first mortgage is likely to escalate subject to the prevailing interest rates in the market at any given time. Before we conclude our discussion on the topic, it is worth mentioning that nearly all creditors permit the debtors acquiring variable rate mortgages to obtain a conventional or typical fixed rate mortgage any time the borrowers wish provided they shell out an average administration or paperwork expense. This amount to be paid as administration fees by the borrowers is subject to the whims and fancies of the lender. In this instance, many lenders demand a fixed charge; others may seek an amount that will lessen over passage of time, while there are many others who will want that the borrower sign and register a new mortgage agreement.
When inflation grips global economy, people may go in for a variable rate mortgage instead of the fixed rate mortgages. This is the perfect time to think about obtaining a VRM since the interest rates in the market are exceptionally high. One may only hope that the days of high inflation are a thing of the past.
In fact, when the interest falls up in the market it is advantageous for the debtors and in such situations; variable rate mortgages are an effective way to evade the higher interest charges both in the case of a person obtaining a new mortgage or recharging an old one. If one desires to reap the maximum benefit from a variable rate mortgage, he or she should reserve on when the interest rates are at their highest or when they are just about to decline. It is important to note that if the interest rates escalate after one has reserved a VRM, negative amortization may come into effect, particularly if the fixed amount paid every month is not sufficient to include the entire interest charges on the loan. In this case, the borrowers will be dismayed over the fact that they would owe a relatively much larger sum of money to the lender that what they had taken at the outset of the mortgage. However, all said and done, it is true that no one can predict as to when the interest rates would go up or begin to decline.
Incidentally, at times you would be surprised to find borrowers opting for variable rate mortgages when the interest charges in the market are relatively less. Substantiating their actions, these borrowers stress that even when the expenses of obtaining a typical mortgage product is insignificant, they would prefer the VRM to reap the benefits of the low interest rates offered by it. Contrary to the general viewpoint, these borrowers say that they would look for a conventional mortgage product only when the interest rates are on a higher end. Although there is some sense in this argument, the fact remains that these people are thinking against the conventional line as when the interest charges are lower, most borrowers would just do the opposite of what these people say.
