ARM vs. VRM: Which Variable Rate Mortgage is Right for You?
Lately, many borrowers are opting for shorter fixed-term mortgages, like a 3-year fixed rate. But we've also seen a shift—more people are going back to variable-rate mortgages as interest rates start to drop.
That said, I recently came across a situation where someone had secured a rate hold with a big bank for a variable-rate mortgage. The only problem? The bank rep didn’t clearly explain what type of variable-rate product they were pre-approved for. So, here's a quick question for you: Do you know whether you’re pre-approved for an Adjustable-Rate Mortgage (ARM) or a Variable-Rate Mortgage (VRM)? They sound similar but have some important differences!
Here’s the Breakdown:
Adjustable-Rate Mortgage (ARM):
With an ARM, your payments can change as the prime interest rate moves up or down. If rates go up, your payments will rise; if they go down, your payments will drop. It’s a floating payment, so you’ll need to adjust as rates shift, but this can be more manageable over time since the changes are gradual.
Variable-Rate Mortgage (VRM):
This one keeps your payments fixed, just like a standard mortgage. But the interest rate can still change. As rates fluctuate, the amount of your payment going toward interest (vs. your principal) will change. If rates rise, more of your payment goes to interest, and less to paying down your mortgage balance. This could cause your mortgage to stretch out longer, or even lead to "negative amortization," where your balance actually increases. We’ve seen this happen over the last few years, especially with the big interest rate hikes. Yikes!
Which One Saves You More?
ARM: This one typically gives you more consistent savings over time. As rates adjust, your payments gradually go up or down. If rates fall, you'll get budget relief with a lower payment. Plus, you won’t risk "payment shock" down the road since the payment change is more gradual. Your mortgage should stay on track to be paid off as expected.
VRM: The VRM offers a predictable monthly payment, which is great—unless rates go up significantly. If that happens, more of your payment will go toward interest, meaning less goes to your principal. This could lengthen your mortgage term or even cause your balance to rise, which might catch you by surprise when it's time to renew. And if rates don’t drop enough to balance out those increases, you could end up paying more interest overall.
A Quick Note on Flexibility:
Both ARMs and VRMs tend to come with lower penalties if you want to switch your mortgage later. So, if you decide to make a change, you won’t be hit with hefty fees. Plus, if rates start to drop, the ARM’s flexible payments will allow your budget to breathe easier.
At the end of the day, your choice between an ARM and VRM comes down to how much you’re comfortable with payment fluctuations. If you can handle a bit of unpredictability, the ARM might be your best bet for more steady savings. But if you like the idea of a fixed payment, just make sure you're keeping a close eye on those interest rates with a VRM—it can be a bit of a wild card.
If you have any questions, don’t hesitate to reach out. Let’s chat about which option makes the most sense for your financial goals and risk tolerance.