Legal Definitions - variable-rate mortgage

A variable-rate mortgage is a type of home loan where the interest rate is not fixed for the entire duration of the loan. Instead, the interest rate can change periodically over time, typically adjusting at predetermined intervals (e.g., annually) based on fluctuations in a specific financial index, such as the prime rate or a benchmark set by the central bank. This means that the borrower's monthly mortgage payments can increase or decrease, reflecting changes in the broader market interest rates. While variable-rate mortgages often offer a lower initial interest rate compared to fixed-rate mortgages, they carry the risk of higher payments if market rates rise.

• Scenario: Emily and Ben are first-time homebuyers who anticipate moving within seven years. They choose a 7/1 variable-rate mortgage, which means their interest rate is fixed for the first seven years, and then it will adjust annually thereafter. They selected this option because the initial interest rate was significantly lower than any available fixed-rate mortgage, making their early monthly payments more manageable while they save for future plans.

  Explanation: This illustrates a variable-rate mortgage because, after the initial seven-year period, the interest rate on Emily and Ben's loan will begin to "vary" or change based on market conditions. They are benefiting from the initial lower rate, but they also accept the future risk of potential rate increases if they still hold the mortgage past the fixed period.

• Scenario: Mark has a variable-rate mortgage that adjusts every year. For the past three years, his interest rate remained stable, leading to consistent monthly payments. However, due to a period of economic growth and inflation, the central bank raised its benchmark interest rate several times. When Mark's mortgage rate reset on its annual adjustment date, the new rate was significantly higher, causing his monthly mortgage payment to increase by $350. This required him to re-evaluate his household budget.

  Explanation: This example clearly demonstrates the core characteristic of a variable-rate mortgage. Mark's interest rate and, consequently, his monthly payment "varied" upwards because the underlying market index, to which his mortgage was tied, increased, directly impacting his loan terms.

• Scenario: Sarah took out a variable-rate mortgage five years ago when interest rates were moderately high. Over the past year, the economy experienced a downturn, and the central bank implemented several interest rate cuts to stimulate economic activity. When Sarah's mortgage rate next adjusted according to her loan agreement, her lender applied the new, lower rate based on the decreased market index. This resulted in a welcome reduction of $180 in her monthly mortgage payment, providing her with more disposable income.

  Explanation: This scenario highlights the potential benefit of a variable-rate mortgage. Sarah's interest rate "varied" downwards due to a decline in the market index, leading to lower monthly payments and illustrating how borrowers can benefit when overall market interest rates fall.