Posted On Aug 16, 2024

When it comes to purchasing a home in Ontario, Canada, one of the most significant financial decisions you will make is choosing the right mortgage. One type of mortgage that is popular among homeowners is an Adjustable Rate Mortgage (ARM). In this article, we will explore what an adjustable rate mortgage is, how it works, and the benefits and drawbacks of choosing this type of mortgage.

What is an Adjustable Rate Mortgage?

An adjustable rate mortgage, also known as a variable rate mortgage, is a type of mortgage in which the interest rate fluctuates based on market conditions. Unlike a fixed rate mortgage, the interest rate on an ARM is not fixed for the entire term of the mortgage. Instead, the interest rate can change at specific intervals throughout the term of the loan, typically every six months or annually.

 

How Does an Adjustable Rate Mortgage Work?

An adjustable rate mortgage works by tying the interest rate to a specific benchmark, such as the Bank of Canada's overnight lending rate. When the benchmark rate changes, the interest rate on the mortgage will adjust accordingly. For example, if the overnight lending rate goes up by 0.25%, the interest rate on the ARM will also increase by 0.25%.

The initial interest rate on an ARM is typically lower than that of a fixed-rate mortgage. This lower initial rate can make the mortgage more affordable, especially for first-time homebuyers who may have a limited budget. However, it's important to note that the interest rate can increase over time, which could result in higher monthly mortgage payments.

 

Benefits of an Adjustable Rate Mortgage

Lower Initial Interest Rate: As mentioned earlier, the initial interest rate on an ARM is typically lower than that of a fixed-rate mortgage. This lower rate can make the mortgage more affordable, especially if you plan to sell your home before the interest rate adjusts.

Flexibility: An ARM can provide more flexibility for homeowners who plan to sell their home or refinance their mortgage in the future. Since the interest rate on an ARM can adjust, homeowners may be able to take advantage of lower interest rates in the future.

Short-Term Savings: If you plan to stay in your home for a short period, an ARM can help you save money on interest payments. This is because the initial interest rate on an ARM is typically lower than that of a fixed-rate mortgage.

 

Drawbacks of an Adjustable Rate Mortgage

Uncertainty: The biggest disadvantage of an ARM is the uncertainty associated with the fluctuating interest rate. Homeowners who choose an ARM must be prepared for the possibility of higher monthly mortgage payments if the interest rate increases.

Lack of Stability: An ARM provides less stability than a fixed-rate mortgage, which can be a disadvantage for some homeowners. If you prefer to have a consistent monthly mortgage payment, an ARM may not be the best option for you.

Refinancing Costs: If you decide to refinance your ARM to a fixed-rate mortgage, you may incur additional costs such as closing costs, appraisal fees, and legal fees.

 

 

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