One of the first decisions homebuyers and mortgage shoppers encounter is the choice between a variable rate or fixed rate mortgage. How do you decide one over the other?
Before we go into factors that govern this decision, we must understand what both mortgage types are:
What is a fixed rate mortgage?
Fixed rate mortgages are set for the duration of the mortgage term. It is so called because the interest rate and payments are fixed.
- The rate is generally higher than the variable rate.
- It remains the same throughout the term of the loan. All monthly payments are also fixed over the lifespan of the loan.
- If interest rates drop after you have locked into a fixed rate, your monthly payments will remain higher than a variable rate.
What is a variable rate mortgage?
A variable rate mortgage is one which fluctuates with market interest rate, referred to as ‚Äėprime rate‚Äô. Mortgage payments may fluctuate with changes in the prime rate or the ‚Äėinterest part‚Äô of the payment varies.
- Variable rates are generally lower than a fixed one
- They are subject to changes in Prime Rate- your monthly payments could differ subsequently.
- If there is an increase in interest rates, your monthly payments may be higher than fixed rate.
Having explained both scenarios, choosing between the two types of mortgage rates pose a difficult decision for most mortgage buyers. Variable rate loans are often more attractive than Fixed rate loans in the beginning, but because the former can change anytime, it is not enough to base your comparisons on initial interest rates alone.
Borrowers are advised to consider their choices in the long-term, and how markets may behave in the future.
The following should guide your decisions
- Security and predictability
Are you comfortable with changes in the future? What if the rates become higher? Do you think you could manage it on a variable rate mortgage? If you are better off with the security and predictability of fixed rate mortgages, then you may want to lock your rates instead.
- Mortgage term
The duration of a mortgage term can determine whether you are okay with your rates. The longer the term of a variable rate mortgage, the longer you would have to deal with fluctuations in interest rates, and subsequent changes in the family budget. Conversely, it would be unfortunate if you have locked in a higher rate for a long period when market rates continue to drop.
- How long do you plan to live in the property?
One of the important things to consider when choosing between fixed and variable rate mortgages is the amount of time you intend to live in your new home. If it‚Äôs for a few years, a variable mortgage rate is the better option because you can adjust plans accordingly, especially with access to online tools such as mortgage calculators.
On the contrary, if you have found your ideal home and want to spend the next 30 years (or so) in it, a fixed rate mortgage is the safer option. From a risk perspective, it is more valuable- you are safe when rates rise and you can refinance when they drop.
An important point to know is neither of the rates are ‚Äėbad‚Äô. It just depends on your circumstances.
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