What is a variable interest rate

Definition of Variable Interest Rate

In real estate, a variable interest rate is a mortgage loan where the rate charged varies based on current market interest rates, which change when banks increase or decrease the posted and discount mortgage rates they charge to borrowers, in response to changes to the Bank of Canada’s overnight target rate (aka: benchmark rate).

Why is this term important?

Variable interest rates fluctuate over time because these rates are based on an underlying benchmark interest rate or index, such as a five-year treasury bill yield, which changes over time.

The advantage of a variable interest rate is that you can end up paying down more of the mortgage loan principal if the underlying interest rate or index price declines. That's because the interest portion of your monthly mortgage payment decreases at the same time, allowing more of that monthly mortgage payment to go to paying off the principal loan. However, if the underlying rates or index rises, your interest payments will also rise, and less of your total mortgage payment will go to paying off the total mortgage debt.

Examples of term

A variable interest rate can start at 6% but then increase to 9% by the end of the loan term—a 3% hike in rates within a five year time period probably won't result in additional monthly payments, but it will mean at the end of the mortgage term you will have paid off less of the principal debt, as a larger percentage of your monthly payment went towards the interest portion.