Fixed Vs Variable Mortgage Rates

August 12, 2023

Taking out a mortgage is one of the biggest life decisions for many individuals, as it commits them to a property for years, perhaps even decades. We all want to own a place of our own, but no one wants to commit to a mortgage that strains their budgets. It's important to understand the difference between fixed and variable rate mortgages to pick one to help you attain your homeownership goal while simultaneously keeping your balance sheet strong. Start revealing the differences now!

Fixed Rate Advantages

Fixed rate mortgages provide individuals with the security of a mortgage payment that always remains the same, which in turn eases budgeting for homeowners. This is due to the fact they now know what their mortgage payment will be for as long as they have the loan, which decreases the likelihood of rising payments placing homeowners in financial difficulty. However, borrowers should note fixed-rate loans only protect rising principal and interest payments. There is no type of mortgage loan, fixed or variable, that can protect homeowners from increased property taxes, increased insurance costs, runaway homeowners association fees, and special assessments.

Another of the primary fixed rate advantages is protection from interest-rate increases, which makes fixed-rate mortgages particularly attractive in a low interest rate environment. Buyers can afford a higher priced property while locking in the low rate, and when interest rates rise, fixed-rate mortgage holders feel no impact. First-time homebuyers may feel more comfortable with fixed-rate loans because they are straightforward, leaving no guesswork. It may be difficult for first-time homebuyers to estimate the total costs of home repairs, utilities, and taxes or assessments, and having a stable mortgage payment makes this adjustment easier.

Continue reading to reveal the major disadvantages of fixed rate mortgages.

Fixed Rate Disadvantages

The security of fixed rate loans comes at a price. At the time a borrower takes out a fixed rate loan, the interest rate is always higher than with a variable rate loan. For example, when the prime rate for fixed loans stands at six percent, prime rates for variables may be around four percent, which translates to a higher mortgage payment. It also means the borrower can afford less in terms of purchase price.

Another disadvantage of these loans is inflexibility. If an individual took out a fixed rate loan at five percent and rates drop to three percent, they must continue paying five percent. Though the borrower can try to refinance, there is no guarantee that he or she will qualify. If the borrower receives approval, there are usually fees, which can eat up many years worth of interest savings. Because of this, refinancing is usually a poor option if the borrower plans to move in the next several years.

Continue to learn about the advantages of choosing a variable rate instead.

Variable Rate Advantage

Variable rates are typically less than fixed rates, at least at the time you take out the loan. This can be a great help for homebuyers who are struggling to qualify for a certain home or find one in a specific community. Unlike fixed rate mortgages, which provide no flexibility, many variable rate mortgages provide different payment options, allowing borrowers to shop for variable rate mortgages that meet their specific needs. For example, a borrower with a variable income may feel more comfortable with a variable rate mortgage that not only offers a lower principal-plus-interest payment but also allows the borrower to make interest-only payments. The borrower can then pay less during slow months and more after a big paycheck. The lower payments on variable rate mortgages leave more cash available for home improvements, savings, and to cover repairs, such as a leaky faucet. The savings can also be used to pay down the principal balance.

Of course, variable rates also come with some disadvantages. Continue reading for details on this.

Variable Rate Disadvantage

All variable rates are essentially introductory rates. Though mortgage rates rarely spike from a low introductory rate to a stratospheric rate, like many credit cards, it's important to remember even a small increase can add hundreds of dollars per month on many mortgages. For example, a one percent increase on a 250,000 dollar loan equals a little over two hundred extra dollars per month. Even an increase of just a few percentage points can price many families out of their own homes, which is the big variable rate disadvantage.

Though rates are usually guaranteed not to fluctuate for the first two to three years, a rate shock can hit borrowers as soon as the guarantee period ends, and if they cannot absorb the increase, they may be forced to sell the home. For this reason, variable rates are not suited for individuals planning to remain in a home for more than a few years. In a down real estate market, variable rate mortgages can lead to foreclosure because when the borrower is faced with a rate shock, the home may lack the equity needed to complete a sale.

Continue reading to learn about how to choose between these two types.

Choosing Between Them

One key question to ask when considering a variable- or fixed-rate mortgage is how long you plan to reside in the home. If you are buying the home you want to raise your children in, a fixed rate loan provides the security you need. A sudden rise of several hundred dollars or more per month may prove a strain, and rising taxes or other expenses may increase the burden. For individuals wanting to live in a home for just a few years, a variable rate mortgage may make more sense, as the higher fixed rate is essentially a premium for long-term stability. If you plan to move in two years, there is no long-term, so saving the money may make sense, especially if it allows you to buy a property that provides significant appreciation. However, before taking out a variable rate loan, make sure you can handle the payment increases in case your plan to move in a few years changes.

The interest rate environment also matters when choosing between them. With low rates, fixed rate mortgages are more attractive. In a high rate environment, locking in a fixed rate could be a mistake, even for the long-term buyer. If you feel rates will decrease, a variable rate mortgage is the way to go.

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