If you're using a real estate broker to help you buy your very first home it is easy to get caught up in the specifics of searching for, choosing, and purchasing the home and forget to worry about the specifics of financing that purchase. Even people who have taken out mortgages before can make mistakes if they're not familiar with all of the risks, so we've put together this article on the risks of going one of the more popular mortgage routes: variable rate.
In a variable rate mortgage, the amount of interest you pay on your loan won't be the same over the length of the loan like it would be if you were buying a home on a fixed rate mortgage. With a variable rate mortgage, the rate will change according to the rate set by the market, which means your monthly payments might never be the same amount twice. Generally speaking, when you apply for a variable rate mortgage, the rate will be listed as Prime (the best rate on the market, offered only to the best customers) plus a certain percentage, like Prime+1%, which means if Prime is 3.5%, your interest rate will be 4.5%.
Most people who take out variable rate mortgages do so in the hope that the prime interest rate will drop over the life of their mortgage so that they end up getting a great deal on their monthly payments and saving a lot of money on overall interest on their loan. When you're caught up in the excitement of searching for a home, it can be easy to focus on this positive scenario and forget that there are risks associated with variable rate mortgages and that they are responsible for a lot of foreclosures.
Everyone who takes out a variable rate mortgage hopes that the rates will end up going down, but there's always the risk that they could go up instead. You should never ignore this possibility, because you could end up over your head very quickly if you aren't careful. The rates could rise beyond your ability to pay them and your house could end up on the list of homes for sale in Vaughan or end up being taken away by the bank.
There is a provision known as a cap that can be applied to a variable rate mortgage to take some of the risk away, but caps have their own risks. When you apply a cap it means your payments on your mortgage cannot rise above a certain amount. However, that does not mean your interest rate doesn't keep rising. Instead of paying it off normally, the extra interest will be added to the principal, increasing the length of time it will take you to pay off the mortgage. If you are unsure about the right mortgage rate type for your needs and what options you have, speak with a knowledgeable and experienced mortgage broker, such as Marcus Tzaferis. Often called on by the media as a financial expert, he has years of experience helping clients in Toronto and across Canada to find the best suited mortgage for their financial needs.