The Variable Rate Mortgage (VRM) is an innovative mortgage product that has become increasingly popular among Canadians in the last several years. Unfortunately, few people understand what they are or how they work, so people tend to shy away from one of the best products available to help them pay down their mortgage faster. The VRM is best suited to individuals who have a higher risk threshold and believe that the bank rate will remain stable relative to fixed term mortgage rates in the near to mid future.

One of the greatest differences between VRMs and fixed rate mortgages is how the rates are set. The chartered banks add a slight premium to the Bank of Canada Rate (so called bank rate) to establish the Prime Rate. Most lenders use the Prime Rate to price their variable rate mortgage products.

The Bank of Canada uses its bank rate to control inflation and our economy. When our economy shows signs of overheating, the Bank of Canada will increase the bank rate to discourage spending and slow the economy, holding inflation to acceptable levels. When the economy is sluggish, the Bank of Canada will reduce the bank rate to encourage borrowing and spending in the hope of heating up the economy. Since the Bank of Canada rate directly affects the Prime Rate, the Bank of Canada rate changes also have an impact on the rates for variable rate mortgages.

The fixed rate mortgages, on the other hand, are based on the yields in the bond market. These yields tend to have greater volatility and fluctuate with political, economic, and corporate conditions.

There are four main components to a VRM product that consumers should be aware of:

• Ongoing "prime minus" or "prime plus" feature.
• Fluctuations in payment amounts.
• Locking-in privileges of each mortgage company.
• Protected or cap rate.

Currently, there are numerous different variable rate mortgage products in the market place. This generally makes it difficult for prospective clients to decide which to choose and impossible for the average Canadian to know the distinctive differences to all of them. A mortgage professional who deals with these products on a daily basis can help you select the best variable rate mortgage to meet your needs.

1. Ongoing "prime minus" or "prime plus" feature.
   This is simply the amount to be deducted from (or added to) the individual bank's prime rate.
   For example, if the bank's prime lending rate is 3.75%, and the variable product you choose is "prime minus 0.75%", your initial rate will be 3.00% adjusted monthly or quarterly as the prime rate changes.
2. Fluctuations in payment amounts.
   The second component is the monthly payment. For some lenders, payments for a variable rate mortgage don't change. If rates go down, more of your payment is applied against the principal. If rates go up, more of your payment is applied against the interest. Other lenders will vary the payment with the fluctuations in prime. So as the prime rate increases, your payment also increases, and as the prime rate decreases, your payment also decreases.
3. Locking-in privileges of each mortgage company.
   The third component is at which point will you elect to "lock in" (convert your variable to a fixed rate) and what "discount" will the lender be prepared to grant. Some institutions offer fully discounted rates at lock in, while others do not.
4. Protected or cap rate.
   The final component is the "protected" or cap rate. This is offered on some variable rate mortgages, and is a guarantee that if interest rates rise above a certain level during the term of your mortgages, your mortgage interest rate would not rise above a pre-determined level (a so-called cap).
   Variable Rate Mortgages are exceptional products for the right clients. It is highly recommended that you get a mortgage consultant's advice on a variable rate mortgage before you take it.