The Dangers and Myths of Variable Rate Mortgages
A variable rate mortgage, fixed-rate mortgage or tracker mortgage is an unsecured loan typically with a variable interest rate on the initial loan repayments, usually based on some base rate of interest chosen by the lender. The loan can be provided by the bank at its normal variable rate/normal base rate. Interest rates rise and fall in time as they are predicted by the market. In this case the initial loan repayments are subject to change according to the variable rate. Variable rate mortgages have several advantages over fixed rate mortgages; such as flexibility of payment, less risk to the bank and a faster repayment time.
It is important to understand what a variable rate mortgage is before applying for one. A variable rate mortgage has an interest that fluctuates. When you take out your loan it is usually for a specific period of time, called a term. After the term, the base rate and variable interest rate are the same. This means that when your term comes to an end; the interest rate and variable interest rate will be the same.
One advantage that a variable rate mortgage has over a fixed-rate loan is flexibility of payment. As the base rate varies, your payments vary according to the rate. If you find the fixed rate mortgage to be more attractive; however you need to be aware of two disadvantages. The first disadvantage is that a variable rate mortgage has a higher interest cost than a fixed-rate mortgage. For this reason many people choose a fixed-rate rather than an adjustable rate mortgage.
The second disadvantage that you need to consider is the potential risk involved. Your variable rate mortgage can be subject to an unforeseen collapse in the market. The SVR may rise suddenly or fall unexpectedly. Because your lender is not guaranteed that the interest rates will remain at their current levels; they are susceptible to losses if there is a sudden decline. Your lender may sell the property to pay the debts before they become significant.
There are various different ways of measuring the performance of a Libor or STRA. The most widely used is the actual amount of funds interest or profit earned by the lending institutions in comparing with the settlement value. The other measure used is the price to cover funds rate, which is the amount of money that the lending institutions would be required to allow you to borrow at the current rate in the event that you were to default on your loan. In order to determine the accurate level of Libor and STRO, you need to obtain the services of a Libor and STRO adviser. It is important to choose an adviser who is a registered Libor or STRO professional with a demonstrated history of successful remortgage services.
As compared with fixed rate mortgages, the variable rate mortgages can provide a more flexible, more convenient way of financing homes. However, there are some disadvantages associated with the variable rate mortgage loans. One of the most common is that variable rates can vary at any time. For instance, if the Bank of England base rate drops from time to time, your variable rate mortgage interest rate may drop as well. In addition, some mortgage lenders limit the amount of changes that take place in variable rate interest rates. For example, some limit the amount that the rate may change per month, while others don’t permit any changes.
Another disadvantage of variable interest rate mortgages is that they tend to be extremely risky for borrowers with poor credit ratings or for borrowers who plan on living for a few years. This is because the borrowers of variable interest rate mortgages are often assigned variable rates above the prime rate during the first year and then they are allowed to float at a certain rate above the prime rate for the next two years. Over the course of the next two years, however, if the borrower does not pay off the principal on his or her mortgage, the floating rate will begin to increase. During this time, the variable rate interest will begin to get out of control and the borrower will pay very high amounts to borrow the mortgage. If the borrower does not control the floating rate, he or she can literally be thrown into a life threatening situation where they may have to sell their home before they even get to live there.
Unfortunately, many borrowers do not fully understand the risks and nuances of variable interest rate loans. For this reason, many people end up making poor financial decisions that cost them their home, sometimes to the point that they cannot afford to live there. Because many lenders do not always clearly spell out all of the terms and conditions of their variable rate loans, potential borrowers should always research variable rate interest loans before signing any papers.