Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Canadian Rollover Mortgage

What it is:

A Canadian rollover mortgage is an adjustable-rate mortgage.

How it works (Example):

An adjustable-rate mortgage (ARM) is a mortgage in which the interest rate varies. The loans are also called variable-rate mortgages or floating-rate mortgages.

The interest rate on the loan may correspond to a specific benchmark (the prime rate, or sometimes LIBOR, the one-year constant-maturity Treasury, or other benchmarks) plus an additional spread (which is also called the margin, and its size is often based on the borrower's credit score). The benchmark plus the spread equals the interest rate on the loan.

To understand how Canadian rollover mortgages affect a borrower's payment, let's assume that a bank offers a $100,000 mortgage to a potential borrower. The interest rate is prime plus 5% with a cap of 10%. If the prime rate is 3%, then the borrower's interest rate is 8% (5% + 3%), and the monthly payment is $733.77. If the prime rate increases to, say, 4%, then the loan's interest rate goes to 9% (5% + 4%), and the payment goes to $804.63.

In many cases, Canadian rollover mortgages have no caps -- no limits on how high and sometimes how low the interest rate can go, and how much they can move in any one year, month or quarter. That's because in many cases, the lender and the borrower will renegotiate the loan rate every few years.

Why it Matters:

The idea behind Canadian rollover mortgages is to accept the risk (and the corresponding potential reward) that rates will change favorably and thus benefit the borrower or the lender. For example, if a borrower takes a loan that currently carries a 7% interest rate, he is hoping that rates will drop and his payments will fall accordingly; the lender, on the other hand, is hoping that interest rates will increase, which raises the amount of profit the loan generates (by increasing the borrower's payments).

As you can see, adjustable-rate mortgages can have complex implications. Thus, as is the case with any mortgage or other loan, borrowers must be sure to read and understand the lender's documentation and contemplate the implications of changes in interest rates. Borrowers should be sure they can handle the worst-case scenario of being forced to make higher payments.