Variable rate mortgage loan
Variable rate mortgage loans are those mortgage loans in which interest rate does not remain fixed and changes as per the fluctuations in the market interest rates. Thus, a person opting for the variable rate mortgage loans is not aware of the monthly payment that he has to make throughout the tenure of loan. There are basically two types of mortgage loans available.
These are fixed rate mortgage loans and variable rate mortgage loans. Unlike fixed rate loans, in variable rate mortgage loans, amount of interest debited in the loan account changes. However, change in the interest rates as applicable on mortgage loans occur as per the terms and conditions decided. Variable rate mortgage loans are also known as adjustable rate mortgage loans as interest is adjusted as per the market conditions. Interest rate attached with these loans is calculated with respect to a base rate plus additional rate as mentioned in the loan initial contract.
Advantages and disadvantages
There are some advantages and disadvantages of variable rate mortgage loans. Let us discuss advantages first. A borrower is able to get a lower initial rate as compared to fixed rate mortgage loans. In some cases, variable rate is substantially lower than the fixed interest rate. Lower interest rates are applied because by offering variable rate mortgage loans, lender is protected against the market fluctuations in the interest rate. Thus, risk is reduced and hence, lender does not mind passing lower rates. Borrower is able to afford the lower monthly payments easily as compared to fixed rate loans.
Other benefit is that finding a lender offering variable rate mortgage loans is easier as most of lenders tend to offer mortgage loans at variable rates. If any person wishes to buy home for a short period, variable rate mortgage loans is one of best options available. It is important to note here that while going for variable rate mortgage loans, a person must read the initial contract terms and conditions carefully. Care must be observed with respect to hidden costs, index rates etc. One of greatest advantages attached with variable rate mortgage loans is that these loan offer flexibility. In these loans, borrower is allowed to repay the capital earlier and there is no penalty applied. By repaying capital early, overall burden and hence cost of loan is reduced. This also shortens the time period required to repay the loan amount.
Regarding disadvantages, it can be said that since all borrowers are not able to apprehend the future interest rate movements, borrower end up in paying more money. Analyzing the rate movement and future rate projection is very important in case of variable rate mortgage loans. Projection of monthly payments should be compared with future income and expenses and only then, any decision should be taken. If a person is not able to apprehend the rates, it is better if he goes for fixed rates. In present times, interest rates on mortgage loans have gone very low and thus, it does not make sense if a person who wishes to stay in home for a long period goes for variable rate mortgage loans. It has been observed that lenders offer lower fixed rates than variable rates for attracting more numbers of customers. By applying hefty closing costs and other charges, they recover their money. A person should be careful about this practice. It is advised here that a person should approach a mortgage broker or any other professional that can guide him in getting variable rate mortgage loans. Usefulness of these loans also depends up on the individual circumstances and requirements. There are also some web sites that can provide important information on variable rate mortgage loans. For example, bankrate.com, eloan.com etc are some web sites.
Some important aspects
Let us discuss some important aspects related to variable rate mortgage loans. Interest rate applicable on above loans changes whenever there is any change in the base rate of the central bank. This change is a resultant of changing costs in the credit markets. In some cases, variable rate mortgage loans are offered at the base rate of the lender. In some countries, these loans are standard loans for offering mortgages and are referred to as mortgage loans. In United States, these are called as adjustable rate mortgage loans. As far as underlying index for these loans is concerned, it varies from one country to another.
For example, in United Kingdom, liBOR or London Inter Bank Offered Rate and Bank of England Repo Rate are used as index rates. In United States, there are many indexes that are used for variable rate mortgage loans. Some of these are CMT or Constant Maturity Treasury, COFI or Cost of Funds Index, liBOR, MTA or 12 Month Treasury Average Index etc. BBSW or Bank Bill Swap Rate is also sometimes used as an index. In other countries, there is a prime lending rate of banks that is published and which is used as in index for variable rate mortgage loans. There are three ways in which index can be applied in above loans. It can be applied directly, or rate plus margin or index movement based. If index is applied directly, this means interest on variable rate mortgage loans would change with the index in an exact manner.
If the risk of lender is increased due to market fluctuations, variable interest rates would definitely be increased. For limiting the risk involved, some lenders offer a rate cap facility. In this facility, maximum interest rate charged on the variable rate mortgage loans is capped. Apart from magnitude of change, cap may also be placed on the frequency of interest rate change.
Though variable rate mortgage loans are less expensive than fixed rate loans, it does not happen always. There are certain circumstances in which variable rate loans become completely undesirable. Contacting a mortgage professional is recommended in such cases.
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