[bean438]

I always thought VRM's were open and that your payment fluctuated with rates.
Many lenders have a 3, or 5 year VRM. Does this mean that your payment stays the same for the term? If so how does "variable" come into play? Does the amortization fluctuate then?

 

[Dana]

I always thought VRM's were open and that your payment fluctuated with rates.
Many lenders have a 3, or 5 year VRM. Does this mean that your payment stays the same for the term? If so how does "variable" come into play? Does the amortization fluctuate then?

Your payment does stay the same, the balance of principal and interest being paid off is what is variable. If the rate goes up, you will be paying less principal and more interest. If the rate goes down, you will be paying more principal and less interest. This is different than a fixed rate mortgage which has a set amortization schedule.

I haven't underwritten a mortgage in years, so I can't remeber what rate they use to base your payments or at what point they adjust your payments. If the variable rate increases significantly the lender will increase your payments to ensure that the interest is being paid.

 

[RussSkinner]

When variable rate mortages first came out, they were open. But that didn't last long. They are now subject to a 3-month interest penalty on prepayment.

You qualify based on the fixed rate. If you're wise, you will leave that payment, with the extra coming straight off principal.

As to the different terms, quite a few lenders have recently added 3-year-term variable rate mortgages. If you want to go variable, but plan to move in 3 years, why take a 5-year term which would require the penalty mentioned above?

 

[houska]

Terms on even open VRM's are quite important. They represent the period of time during which the bank cannot change the conditions.

Example: I have a P-0.75 open VRM that I got in 2007, just before the crisis. It has a 5 year term. Since it is open, I can make principal repayments at any time without penalty, and could pay it down to zero if I wanted to.

However, since the VRM has a 5 year term, the bank cannot change the conditions on me. We've all seen how HELOCs (which have no term - they are demand loans) which used to be at prime were reset unilaterally by the banks to P+1. I'm sure my bank would love to do something similar to my VRM, but it cannot since it is bound to the loan conditions for the duration of the term. However, I will need to negotiate with them (or others...) when the term is up in 2012 and what the rate will reset to will depend on then-current market conditions.

Note that most VRMs are closed. In that case, you can't pay them down willy nilly, rather are subject to whatever are the repayment terms (and potential penalties) in your contract for the duration of the term. In the market conditions that prevailed when I was getting my mortgage, many banks were offering P-0.75 5 year closed. The one I went with offered me P-0.75 5 year open; it would have also offered me P-0.85 5 year closed but the loss of flexibility was not worth the 0.1 to me.

 

[Racer]

Houska nailed the answer to that question.

There are only two types of loans - a term loan and a demand loan. In a term loan, the lender/borrower can only change the loan conditions at the end of the term.

In a demand loan, the lender can change the loan conditions at any time by "calling" the loan -- ie, demanding repayment of the loan, in full, immediately -- and then setting up a new loan with that lender or another lender. That's why HELOC debtors had a practical choice of either acceding to the higher interest rate or paying the loan in full (which would mean getting a loan from someone else to pay off the demanded balance) -- everybody knew that the loan could be called at any time.

In our case, we "negotiated" the rate increase down from the proposed rate of Prime+1 to Prime+0.5, but we knew our bargaining position was quite weak.

Lenders love HELOCS for this reason. They sell it to you as something that provides you with additional flexibility "oh, you can "lock up" a HELOC into a regular mortgage at any time", but the fact is that this kind of demand loan provides the lender with the exact same amount of flexibility.

Most (all?) variable rate mortgage lenders allow you to choose to go from variable to fixed rate at any point during the term. But the people I know who have done that have discovered that there is a 3-month delay written in to the fine print, so that the value of anticipating a rate hike is diminished. Especially since the Bank of Canada tells their bank customers and members of the public at the same time about what to expect in terms of the overnight lending rate they will be charging to the banks (can't remember what it's called - Bank of Canada prime?), which in turn is used to set each bank's prime rate.

 

[cardhu]

Your payment does stay the same, the balance of principal and interest being paid off is what is variable.

Depends on which mortgage product you select …

Some VRMs are open.
Some VRMs are closed.
Some VRMs hold the payment steady while the amortization fluctuates (ie. the amount of each payment that is principal fluctuates)
Some VRMs hold the amortization steady while the payment fluctuates.(ie. the amount of each payment that is principal follows the conventional pattern (more or less))

Lotsa variations.