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Variable-rate Adjustment Frequency

When prime rate starts climbing, so will the payments of most variable-rate mortgage holders.

Some people’s variable-rate payments will climb faster than others. That’s because some lenders pass along rate increases quicker than others.

(Note: Things work a little differently for people with fixed-payment variable-rate mortgages. See below.)

Most lenders pass along rate increases as soon as prime rate changes, or on the first day of the following month.  Others give you more time.  ING Direct, for example, only changes its variable rate (for existing customers) every three months. The date of change is based on the borrower’s interest adjustment date. In a rising rate environment, this policy definitely saves some interest.

To see how much interest, we ran a quick scenario.  It compared ING’s rate adjustment policy to the common lender policy of raising variable rates as soon as prime rate increases.

The scenario assumed a $250,000 mortgage, 25-year amortization, 5-year term, a June 1 closing date, and a 2.75% prime rate increase (in 25 bps increments following each BoC meeting).

The results were that ING’s variable saved roughly $540 in interest over the term.  That’s equivalent to saving about five basis points off the interest rate–assuming that rates do rise 2.75% and then average out to no increase/decrease for the remainder of the term.

Mind you, when prime rate eventually falls, this interest effect works in reverse. Yet, given today’s emergency-level 0.25% overnight rate, many would argue that the odds are greater of rates increasing in the next five years than decreasing.

In a nutshell, if you’re getting a variable mortgage today, it’s worth keeping the lender’s rate adjustment policy in mind.


Sidebar: Some variable-rate mortgages offer a “fixed payment” option. In this case, as rates go up, the payment stays the same, but you pay more interest and less principal. The exception is when rates increase so much that you aren’t paying enough interest each month. In that case, the lender will typically raise your payment or require extra payment to cover the interest due.