What Is an Adjustable-Rate Mortgage (ARM)?
Variable mortgages have been a popular choice among Canadians for several reasons. They have historically saved homeowners money on the interest portion of their mortgages. When interest rates hit all-time lows, many Canadians turned to variable mortgages to navigate stricter mortgage qualification requirements imposed by the stress test.
Many homebuyers opted for a variable rate to save money over fixed rates, as the benefits outweighed the risks at the time. Borrowers may qualify for larger loan amounts or more affordable monthly payments by choosing a variable rate.
In Canada, there are two types of variable mortgages: adjustable rate (ARM), which has payments that adjust with changes to the prime rate and variable rate (VRM), which has fixed payments that do not adjust with changes to the prime rate. This post provides an in-depth look at ARM mortgages and how they work, helping you decide whether they are the right mortgage solution for your circumstances.
Key Takeaways
- An adjustable-rate mortgage (ARM) has a fluctuating interest rate, and the monthly payments change with your lender’s prime rate.
- ARMs offer the potential for immediate cost savings if interest rates fall, compared with fixed-rate and VRM mortgages.
- ARMs are suitable for those who can withstand higher payments, as those higher payments are realized immediately if interest rates rise.
What Is an Adjustable-Rate Mortgage (ARM)?
An adjustable-rate mortgage (ARM) is a type of variable mortgage where payments fluctuate with changes in the lender’s prime rate. The principal portion of the mortgage remains the same throughout the term, maintaining your amortization schedule.
If the prime rate changes, the interest portion of the mortgage will automatically adjust accordingly, increasing or decreasing based on whether rates have risen or fallen. This means you could immediately face higher mortgage payments if interest rates increase and lower payments if rates decrease.
ARM vs VRM: Key Differences
ARMs and VRMs share some similarities: when interest rates change, so will the interest portion of the mortgage payment. However, the key differences lie in how the payments are structured.
With both VRMs and ARMs, the interest rate adjusts when the prime rate changes; however, the adjustment is reflected differently. With an ARM, the payment adjusts with changes in the interest rate. With a VRM, the payment does not adjust; only the proportion allocated to principal and interest does. This means the amortization adjusts with interest rate changes.
ARMs have a fluctuating mortgage payment, with the principal portion remaining the same while the interest portion adjusts with changes in the prime rate. This means your mortgage payment could increase or decrease at any time due to changes in interest rates. This keeps your amortization schedule on track.
VRMs have a fixed mortgage payment that does not change. This means changes to the prime rate affect not only the interest portion of the mortgage payment but also the principal portion. As your interest rate changes, the portion of your mortgage payment that goes toward principal will adjust accordingly. This adjustment keeps your mortgage payment fixed. A change in your lender’s prime rate could affect your loan’s amortization and cause you to hit your trigger point and, eventually, your trigger rate, resulting in negative amortization.
| ADJUSTABLE-RATE MORTGAGE (ARM) | VARIABLE-RATE MORTGAGE (VRM) | |
|---|---|---|
| Payment Adjusts | Yes | No |
| Principal Component | Unaffected | Changes to compensate for changes in the interest component |
| Interest Component | Adjusts with prime rate changes | Adjusts with prime rate changes |
| Amortization | Unaffected | Affected by prime rate changes |
| Rates increasing | Monthly payment increases – your cash flow decreases | Amortization increases – it takes you longer to pay off your mortgage |
| Rates decreasing | Monthly payment decreases – your cash flow increases | Amortization decreases – you become mortgage-free faster |
| Trigger Rate Risk | No | Yes If the interest component is reducing your principal payments, your balance and amortization will increase because mortgage payments remain unchanged. |
| Trigger Point Risk | No | Yes You can owe more than your original mortgage at the beginning of your term if you don’t make additional prepayments. |
| Renewal Risk | No | Yes If your mortgage balance and amortization have increased, you’ll have to prepay any extra balance and return the amortization to your original schedule. |
| Payment Shock Risk | Yes When you renew at maturity, if the interest rate is higher. | Yes When you renew at maturity, if the interest rate is higher. At renewal, with any ballooned mortgage balance from hitting your trigger point or trigger rate. At renewal, you’ll need to return your amortization to its original schedule. |
| Savings | Pay Now / Save Now If rates increase, you’ll pay more for your mortgage payments but stay on track with your amortization schedule. If rates decrease, you’ll free up room in your monthly cash flow. | Pay Later / Save Later If rates rise, you could defer changes to your cash flow, especially if inflation is high. If rates decrease, you’ll reduce your mortgage amortization. If rates decrease, you’ll free up cash flow at renewal by returning to your original amortization schedule or continuing with your remaining amortization to be mortgage-free sooner. |
| Costs | If rates increase, higher payments can restrict your cash flow. | If rates increase, the buildup of interest payments can result in a much higher balance at renewal. If rates increase quickly, you may need to refinance to restore your amortization to its original schedule. (Refinance rates are typically higher than renewal rates) |
| Suitability | Most suitable when rates have peaked, and the spread between fixed and variable 5-year rates is not significant enough to lock in long-term rates. | Most suitable for your primary residence when rates have peaked, and you’re looking to become mortgage-free faster. Most suitable for your investment property when you’re looking to extend your mortgage interest over longer periods (to reduce your rental income). |
How Fixed Principal Payments Impact Your ARM
With an ARM, the amount that goes toward paying your mortgage principal remains the same throughout the term. This means that with an ARM, the portion of the mortgage payment that goes toward reducing your mortgage balance remains constant, reducing amortization regardless of interest rate changes. Since mortgage payments can change if interest rates rise, this type of mortgage may be best suited for those with the financial flexibility to handle any potential increases.
Defining Your Mortgage Goals with an ARM
An adjustable-rate mortgage can potentially help you save significant money on the interest you will pay over the life of your mortgage. You would realize savings immediately, as falling interest rates would lower your mortgage payments.
Additionally, adjustable mortgages have lower discharge penalty calculations than fixed-rate mortgages if you need to break your mortgage before maturity. An ARM may be a good fit if you’re a well-qualified borrower with the cash flow through your income or additional savings to weather potential increases in your budget. An ARM requires a higher risk appetite.
Example: Adjustable-Rate Mortgage Performance in 2025
Let’s look at how an ARM performed in 2025 as prime rates changed alongside the BoC policy rate. The table below illustrates how monthly mortgage payments would change for a $500,000 mortgage with a 25-year amortization and a 5-year term.
In 2025, monthly payments decreased by $216.52 ($2,981.51 – $2,764.99) from the highest payments at the beginning of the year to the lowest at the end of the year, driven by changes in the prime rate.
| Month | BoC Policy Rate | Prime Rate (Policy Rate +2.2%) | Monthly Mortgage Payment |
|---|---|---|---|
| January | 3.00% | 5.20% | $2,981.51 |
| February | 3.00% | 5.20% | $2,981.51 |
| March | 2.75% | 4.95% | $2,908.40 |
| April | 2.75% | 4.95% | $2,908.40 |
| May | 2.75% | 4.95% | $2,908.40 |
| June | 2.75% | 4.95% | $2,908.40 |
| July | 2.75% | 4.95% | $2,908.40 |
| August | 2.75% | 4.95% | $2,908.40 |
| September | 2.50% | 4.70% | $2,836.23 |
| October | 2.25% | 4.45% | $2,764.99 |
| November | 2.25% | 4.45% | $2,764.99 |
| December | 2.25% | 4.45% | $2,764.99 |
How Is an Adjustable-Rate Mortgage Expected to Perform in 2026?
The table below illustrates the impact on monthly mortgage payments for the same $500,000 mortgage with a 25-year amortization and a 5-year term. We’ve used predictions for where interest rates may be headed in 2026 to forecast how an ARM could perform over the year.
In 2026, monthly payments are not expected to vary significantly from the highest payment at the beginning of the year to the lowest at the end of the year. This assumes early predictions are correct and there are no changes in the BoC policy rate, which affects the prime rate.
| Month | BoC Policy Rate | Prime Rate (Policy Rate +2.2%) | Monthly Mortgage Payment |
|---|---|---|---|
| January | 2.25% | 4.45% | $2,764.99 |
| February | 2.25% | 4.45% | $2,764.99 |
| March | 2.25% | 4.45% | $2,764.99 |
| April | 2.25% | 4.45% | $2,764.99 |
| May | 2.25% | 4.45% | $2,764.99 |
| June | 2.25% | 4.45% | $2,764.99 |
| July | 2.25% | 4.45% | $2,764.99 |
| August | 2.25% | 4.45% | $2,764.99 |
| September | 2.25% | 4.45% | $2,764.99 |
| October | 2.25% | 4.45% | $2,764.99 |
| November | 2.25% | 4.45% | $2,764.99 |
| December | 2.25% | 4.45% | $2,764.99 |
Why Choose an Adjustable Mortgage Rate?
There are several benefits to choosing an adjustable mortgage, including the potential to realize immediate savings if interest rates fall and lower penalties for breaking the mortgage than fixed mortgages. There are additional benefits to choosing an ARM over a VRM, as your amortization stays on track regardless of interest rate changes.
When compared to fixed-rate mortgages, ARMs offer the benefits of much lower penalties should you need to break the mortgage or wish to switch to a fixed rate in the event interest rates are expected to rise. Variable and adjustable mortgages have a penalty of 3 months’ interest, whereas fixed mortgages typically charge the higher of either 3 months’ interest or the interest rate differential (IRD).
Compared to VRMs, an ARM offers the advantage of immediate adjustments to your mortgage payments when the prime rate changes. VRMs, on the other hand, won’t realize these adjustments until renewal. If interest rates rise significantly over your term, you may end up with negative amortization on your mortgage and hit your trigger rate or trigger point. When this happens, you will be required to catch up on your amortization schedule at renewal, which could result in a payment shock with significantly larger payments.
Which Variable Mortgage Rate Product is Best to Choose?
The best variable mortgage product will depend on your individual circumstances, including your financial situation, risk tolerance, and short and long-term goals. VRMs offer stability through fixed payments, making it easier to maintain a budget for those who prefer to know exactly how much they will pay each month. ARMs offer the potential for immediate cost savings and lower mortgage payments should interest rates decrease.
Benefits of VRMs for Borrowers
- Adjustable Interest Rates: VRMs have interest rates that can fluctuate over time in response to prevailing market conditions. This can be advantageous as borrowers may benefit, as they have historically, from lower interest rates, resulting in potential cost savings in the long run.
- Greater Financial Control: A lower prepayment penalty on variable mortgages makes it less costly to extend the mortgage repayment period through refinancing to the original amortization, and the potential to benefit from lower interest rates gives borrowers greater financial control. This ability allows borrowers to adjust their mortgage payments to better align with their current financial situation and make strategic decisions to optimize their overall financial goals.
- Reduction in Taxable Income: If the VRM is on an investment property, a borrower can increase the balance (mortgage amount) and the time (amortization) they take to pay down their mortgage, potentially reducing their taxable rental income.
These advantages make VRMs a suitable option for incorporated individuals or investors who value flexibility and control in managing their mortgage payments. However, these benefits also carry an increased risk of default and the possibility of higher taxable income. It is recommended that borrowers consult a financial planner before choosing a variable mortgage to take advantage of these benefits.
Benefits of ARMs for Borrowers
- Adjustable Interest Rates: ARMs have floating interest rates that adjust periodically with the lender’s prime rate, based on market conditions. Historically, it has benefitted borrowers by enabling them to take advantage of lower interest rates to save on interest-carrying costs.
- Greater Financial Control: Lower prepayment penalties on ARMs make it less expensive to refinance and extend your mortgage repayment term, while lowering your payment gives you more control over your finances. With a refinance, you can adjust your mortgage payments to better match your current financial situation and make smarter decisions to meet your overall financial objectives.
- Increased Cash Flow: ARMs realize interest rate reductions on their mortgage payment whenever rates decrease, potentially freeing up cash for other household or savings priorities.
ARMs can be a beneficial option for individuals and households with well-planned budgets, a shorter time horizon for paying off their mortgage, and who do not want to increase their mortgage amortization if interest rates rise. With an ARM, initial interest rates have historically been lower than those of a fixed-rate mortgage, resulting in lower monthly payments.
A lower payment at the onset of your amortization can be advantageous for those on a tight budget or who want to allocate more funds toward other financial goals. Borrowers should carefully consider their financial situation and assess the risks of an ARM, including the possibility of higher payments if interest rates rise during the mortgage term.
Frequently Asked Questions about ARMs
How does an ARM differ from a fixed-rate mortgage in Canada?
An ARM has an interest rate that adjusts based on the prime rate over the mortgage term. This can result in varying monthly mortgage payments if interest rates rise or fall over the term. Fixed-rate mortgages have an interest rate that remains the same throughout the mortgage term, resulting in fixed mortgage payments.
How is the interest rate determined for an ARM in Canada?
ARM interest rates are set based on the BoC policy rate, which directly influences lenders’ prime rates. Most lenders set their prime rate at the policy rate plus 2.20%. They will then use the prime rate to set their discounted rate, typically a combination of their prime rate plus or minus additional percentage points. The discounted mortgage rate is the rate they offer to their clients.
How can I predict my future payments with an ARM in Canada?
Predicting future payments with an ARM is challenging given the uncertainty around BoC policy rate decisions. However, staying up to date on industry news and expert predictions can help you estimate potential future payments based on economists’ forecasts. Once the discount on your adjustable mortgage rate is set, you can use the BoC policy rate predictions to estimate changes in your mortgage payment using nesto’s mortgage payment calculator.
Can I switch from an ARM to a fixed-rate mortgage in Canada?
Yes, you can switch from an ARM to a fixed-rate mortgage at any time during your term. However, you will pay a penalty of 3 months’ interest if you switch to a new lender before the term ends. You also have the option to convert your ARM mortgage to a fixed-rate mortgage without switching lenders. While this option may not incur a penalty, it may come with a higher fixed rate at the time of conversion.
What happens if I want to sell my property or pay off my ARM early?
If you sell your property or pay off your ARM early, you will be subject to a 3-month prepayment penalty, similar to a VRM.
Final Thoughts
Choosing an adjustable-rate mortgage (ARM) over other mortgage products will depend on your financial ability and risk tolerance. An ARM may be suitable if you are financially stable and have the risk appetite for potentially fluctuating payments during your term. An ARM can offer lower interest rates and monthly payments than a fixed-rate mortgage, making it an attractive option.
The key to determining whether an ARM is suitable for your next mortgage is to thoroughly assess your financial situation, consult a nesto mortgage expert, and align your mortgage selection with your short and long-term financial goals.
Why Choose nesto
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