Adjustable Rate Mortgages

Jordan Clermont, BRX Mortgage INC. FSRA #13463

mortgages@jordanclermont.ca 

226 582 4983

The Two Types of Variable Mortgages

Adjustable-Rate Mortgage (ARM)— Fluctuating Payments

This article focuses primarily on this specific mortgage type. With a variable-rate mortgage of this kind, your regular payment amount changes whenever your lender adjusts its prime rate. Because prime rates directly reflect the Bank of Canada's policy announcements, rate shifts will alter what you pay—a topic explored thoroughly throughout this piece.

Variable-Rate Mortgage (VRM) — Fixed Payments

A VRM is a variable mortgage product featuring fixed base payments. In this setup, changes in interest rates adjust the balance between principal and interest within each payment rather than the total amount due. When interest rates rise, a larger portion of your payment goes toward interest, leaving less for the principal and potentially extending your overall amortization timeline. This topic is explored in detail in a separate article.

Understanding Variable Rates

A variable rate adjusts dynamically in response to broader market movements. Each financial institution sets its own prime lending rate. Variable-rate mortgages are calculated using the following formula:

Mortgage Rate = Prime Rate ± Discount/Premium

Where does the Prime Rate come from?

It begins with the Bank of Canada, which establishes the official policy interest rate. Financial institutions then add a margin to ensure profitability. This profit margin accounts for why a bank's prime rate sits slightly higher than the Bank of Canada overnight rate. Consequently, whenever the Bank of Canada revises its rate, commercial banks typically adjust their prime rates shortly after, directly impacting your mortgage payments.

Understanding Discounts and Premiums

A lender adjusts its prime rate up or down using a discount or premium based on the borrower's risk profile.

How do we calculate the Rate

Let's use an example of a $300,000 mortgage balance with 30 year amortization.


Your rate will be quoted to you as Prime - x.xx. Lenders Prime Rate is currently 4.45 with a discount of 0.75 your rate would be Prime(4.45) - Discount(0.75) = 3.7%.  

Your mortgage payment is $1380

Scenario 1: Bank of Canada lowers policy rate by 0.25%

Prime would change to 4.20% the discount remains the same for the mortgage term.

So our rate would change to Prime(4.20) - Discount(0.75) = 3.45%

Your mortgage payment decreases $40 to $1340 per month

Scenario 2: Bank of Canada raises policy rate by 0.25%

Prime would change to 4.7% again the discount remains the same for the term of the mortgage.

So rate would change too Prime(4.7) - Discount(0.75) = 3.95%

Your mortgage payment increases $40 to $1420 per month

How often can my rate change?

The Bank of Canada meets 8 times per year you can see their schedule on their website.  When the Bank of Canada meets they can either hold, raise or lower the rate.  This is done to manage the economy and inflation targets.  When the Bank of Canada adjusts their prime rate up or down it affects your mortgage payment.  

Does my Payment Change when the Rate Changes?

Yes, when the Bank of Canada either hikes or lowers rates your payment will change.  The bank of Canada historically will not adjust policy rates by more than 0.25% at a time.  When the bank of Canada changes their policy rate Lenders will instantly change their prime lending rate up or down to match the Bank of Canada..

What if I don't Want a Variable Rate anymore?

Many lenders make it easy to switch to a fixed rate without breaking your mortgage and paying a penalty.  The only drawback to this is sometimes rates that are offered may not be as competitive as rates that are offered to new clients.  This is due to the fact that lenders know that they don't have to compete with anyone for your business.

The 3-Month Interest Break Penalty (The Biggest Selling Point) 

The single greatest advantage of variable-rate mortgages over fixed-rate mortgages is the exit penalty. If a borrower needs to break a variable mortgage (due to selling, moving, or refinancing), the penalty is almost universally capped at 3 months' interest. With fixed mortgages, lenders charge the greater of 3 months' interest or the Interest Rate Differential (IRD), which can easily cost tens of thousands of dollars. 





Frequently Asked Questions

1. What is a variable-rate mortgage?

A variable-rate mortgage is a home loan where your interest rate adjusts dynamically over time based on changes to your financial institution's prime lending rate.

2. What is the difference between an ARM and a VRM?

In an adjustable-rate mortgage (ARM), your monthly payment changes whenever the prime rate moves, keeping your amortization timeline on track. In a fixed-payment variable-rate mortgage (VRM), your total payment stays constant, but the portion allocated toward principal versus interest shifts as rates change.

3. How is my variable rate determined?

Your rate is calculated as: Mortgage Rate = Prime Rate ± Discount/Premium. For instance, if Prime is 4.45% and you have a discount of 0.75%, your contract rate is 3.70%.

4. What is the prime rate, and who sets it?

Each individual bank or lender sets its own prime lending rate. It serves as the baseline interest rate for variable loans and lines of credit.

5. How does the Bank of Canada influence my mortgage rate?

The Bank of Canada sets the official policy interest rate (overnight rate). Commercial lenders add a profit margin on top of this rate to establish their prime rates. When the central bank raises or lowers its rate, lenders usually adjust their prime rates by the same margin shortly after.

6. How often can the Bank of Canada change its policy rate?

The Bank of Canada meets eight times per year on a pre-scheduled calendar to announce whether it will raise, lower, or hold the policy interest rate.

7. Does the Bank of Canada only change rates by 0.25% at a time?

No. While 0.25% (25 basis points) is the standard incremental adjustment, the Bank can hold rates at 0.00% or implement larger moves (such as 0.50%, 0.75%, or 1.00%) during rapid economic shifts.

8. What is a mortgage rate discount?

A discount is an amount subtracted from the prime rate (e.g., Prime – 0.75%) offered to well-qualified borrowers with strong credit profiles.

9. What is a mortgage rate premium?

A premium is an amount added to the prime rate (e.g., Prime + 0.50%), typically applied to borrowers with weaker credit profiles or non-traditional income.

10. Can my discount or premium change during my term?

No. Your discount or premium is legally locked in for the entirety of your mortgage term. Only the underlying prime rate moves.

11. What is the penalty to break a variable-rate mortgage early?

Variable-rate mortgages almost always carry a penalty equal to three months of interest, making them far cheaper to exit or break than fixed-rate mortgages (which can charge heavy Interest Rate Differential penalties).

12. Can I switch from a variable rate to a fixed rate?

Yes. Most lenders allow borrowers to convert to a fixed rate at any point during the term without paying an early-exit penalty.

13. Are there restrictions when converting to a fixed rate?

Lenders typically require you to lock in for a fixed term that is equal to or greater than the time remaining on your variable contract, and the rates offered may not match promotional rates given to new clients.

14. What happens when the prime rate drops on an adjustable mortgage?

On an ARM, your regular monthly payment drops automatically, reducing your monthly cash outflow while maintaining your original amortization schedule.

15. Who is a variable-rate mortgage best suited for?

A variable-rate mortgage is ideal for borrowers who have financial flexibility in their monthly budget to absorb rate increases and who value the flexibility of a low three-month interest penalty if they need to sell or refinance early.