How does a variable rate mortgage function?

A variable rate mortgage is designed to have an interest rate that fluctuates based on market conditions, specifically tied to benchmark interest rates, such as the prime rate. This means that the interest charged on the mortgage can increase or decrease over time, impacting the overall cost of borrowing. As market interest rates rise, the interest on the variable rate mortgage may also rise, leading to higher monthly payments. Conversely, if market rates decline, the interest charged may decrease, potentially lowering the monthly payments.

The nature of this type of mortgage means that the cost of borrowing can change during the term of the loan, providing flexibility and the opportunity for savings if interest rates drop. This characteristic distinguishes variable rate mortgages from fixed-rate mortgages, where the interest rate remains constant for the entire term of the loan.

Other options, such as the idea that interest rates remain constant or that monthly payments do not change, do not accurately capture the dynamics of a variable rate mortgage, which inherently involves variability in interest based on market conditions. Additionally, the suggestion that new terms are set every five years is more reflective of fixed-rate mortgages with a term length rather than the inherent nature of a variable rate mortgage's fluctuating interest component.