Real estate loans are often set up as a variable rate mortgage or adjustable mortgage rate. VRMs often start out with a low interest rate, sometimes called a teaser rate, in order to draw borrowers to them. The interest rate is then adjusted up or down, usually in periods of six months for each adjustment, so the rate will reflect any current market rates. Limits can be set to specify how high or how low the interest can be adjusted and how often the changes are made.
The opening interest rate can be fixed for two or three years. When that time has expired, the rate can be adjusted as often as every month for the remainder of the 28 or 27 years of a 30-year loan.
The periodic interest rate adjustments are based on several indexes, the most common being the Cost of Funds Index (COFI). Other lender-favored indexes are the 1-year Constant Maturity Treasury or the London Interbank Offered Rate (LIBOR). Some lenders use their own cost of funds index. Taking out a variable rate loan means that a borrower’s monthly payments can vary from month to month due to the lenders use of changing interest rates. Terms of the loan can also change because of the variable rates.
The lender makes a profit when a variable interest rate rises and the borrower saves money when the interest rates fall. It can be a gamble for both parties especially if the market conditions are unstable. Some borrowers take out a VRM when a fixed rate loan can’t be opened for some reason.
When looking for a variable rate mortgage, be sure the lender’s interest rates are linked to a legal index, otherwise the lender can increase or decrease the rate at its own choosing. Also, arrange the loan so that the capital can be paid back early in order to reduce the loan amount and not be penalized for it. Paying part of it early will also shorten how long it takes to pay off the debt.
Some countries only offer a variable rate mortgage and so they simply call them mortgages. Keep that in mind when you are looking for loans outside the United States.