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payment shock - andrew galler mortgages

Floating rate mortgages became more popular this year as the interest rate spread over fixed rates widen to as much as 2%. Historically, about 20% of borrowers chose floating rates, but that increased to over 50% with speculation the Bank of Canada would not close the gap too quickly. The Bank’s recent 1% rate increase surprised the market and underscored floating rates are unpredictable.

Floating rate mortgages are either Variable Rate (VRM) or Adjustable Rate (ARM) and react differently to prime rate increases. ARMs adjust the payment immediately or soon after rate changes to maintain the original amortization. VRMs hold the payment steady, but since more of the payment goes to interest, the amortization is lengthened. If rates rise substantially to where the payment no longer covers the interest, the payment will also increase.

The ARM is the “pay me now” option and VRM is the “pay me later”. The ARM keeps your debt repayment on schedule while the VRM postpones some principal repayment raising the lifetime interest cost and can require a higher payment at renewal to bring the amortization back to the original agreement. The implication of rate increases is in the fine print, so call me if you want to know more.

Andrew Galler


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