Difference between ARM and VRM Mortgage Products
What is the difference between an ARM (Adjustable rate mortgage) and a VRM (Variable rate mortgage)?
This is a great question and one that has become extremely relevant over the past few years. Both options are tied to the lender’s Prime lending rate. For example, you may receive an option for your mortgage rate to be “Prime minus 1%”, this simply means that your mortgage interest rate would be the lender’s Prime rate minus 1%. If the Prime lending rate was 6.7%, your effective interest rate would be 5.7% (6.7% - 1%). As the Prime lending rate is tied to the Bank of Canada’s (BOC) benchmark rate, the Prime rate will usually increase or decrease with this rate. If this rate increases, then your mortgage rate will increase as well. Example is if the BOC increases their rate by 0.50% then the Prime rate will become 7.2% (6.7% + 0.50%) and your mortgage rate will become 6.2% (7.2% - 1%).
How does this affect you if your option is an ARM?
With this option your interest rate will increase to 6.2% and you will receive notice from your lender that your interest rate has increased which will translate to your mortgage payment increasing enough to incorporate the increase in the interest that is now being charged to you. The benefit of this is that your original amortization will not be affected as you are making the payments to pay down all the interest and are still paying down the principal amount of your mortgage at the rate that was originally set up. The disadvantage is that your mortgage payment is now a higher amount, which may cause some hardship for your daily and monthly lifestyle. The opposite is true as well. If the BOC lowers their benchmark rate, your interest payable will decrease, and your payments will decrease in amount as well.
How does this affect you if your option is a VRM?
With this option your interest rate would increase in the same manner as the example above. The difference is that your mortgage payment will not change and remain the same. The additional interest that is being charged will then be absorbed in your payment causing less of your payment being allocated to your principle. This will effectively increase your amortization as since less money is being allocated to your principle, it will take a longer period to pay off the entire mortgage. The advantage is that your mortgage payment remains the same, so your daily and monthly budgeting and lifestyle is easier to manage. The disadvantage, besides the increase to your amortization, is that if the Prime interest rate rises to an amount that causes your entire mortgage payment to be completely interest of worse yet, the payment does not even cover the full amount of interest, you will hit what is called a Trigger rate. The Trigger rate will usually cause the lender to contact you and demand that you bring your mortgage back to the original amortization. You may be required to produce a large sum of funds; your mortgage payment may increase dramatically or a combination of both. This is what many homeowners faced during the unprecedented amount of increase in the BOC rates during 2022 and 2023. The increase of Prime from 2.45% to 6.7% caused many to face this exact issue. The opposite can be an advantage as well. If the BOC lowers rates, more of the payment is allocated to the principle and less to interest, effectively decreasing the amortization.
Both options are great options but do not come without risk. Please contact us for a free evaluation of your situation and make your decision with all the information that is available.
Victor Sodia and Taufeeq Ramin
Mortgage Agents Level 2
Mortgage District Inc.
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