Variable vs Fixed Rate Mortgages
When making your mortgage payments you are making payments on the principal and the interest. In a fixed rate mortgage you are making the same payments every month on the principal and interest. It’s possible for every bank to have a different but similar fixed rate. The fixed rate is determined on the economy and prime rate (central bank lending rate) at the time of your loan. It is fixed which means that everyone who applies for a fixed rate mortgage will be getting that rate as well. When you are locked into a fixed term agreement (usually 1, 3 and 5 year terms) your interest rate will not change depending on any economic factors. These rates are ideal for people who are making budgets before hand or who do not have the flexibility of being able to make different payments every month. There are no surprises and it is generally less risky even if you probably can end up paying more in interest. In economic terms, with a fixed rate mortgage you make the assumption that interest rates will go up in the coming years.
On the other hand with a variable rate mortgage, it is possible to save money in the long run in comparison to a fixed rate. A variable rate mortgage fluctuates with the prime rate at the central bank. The central bank will adjust the prime rate depending on various economic factors. This means that the interest rate on your mortgage loan can change given what the prime rate is set at. So, if there is less need to budget and more room for some risk, a variable rate may be the way to go.
It is important to know that you’re not completely locked into the type of rate you choose for the duration of your mortgage unless you believe that you can pay it off in a short number of years. It might be worthwhile for you to use a mortgage calculator to get a better idea of where you stand. Depending on the term you decide to take (1, 3 or 5 generally), you can renew your loan and go with a different type of rate. For example, if when you first get your mortgage money is tight and you need to keep to a strict budget for the foreseeable future, you can put your mortgage in 3 year fixed rate term loan. By the end of your 3 years you will not have paid off your whole loan, unless you have a stroke of luck and win the lottery or get a great paying job, but it is possible you may have more flexibility. Perhaps in those years you received a raise or are able to afford more and risk a variable rate. As aforementioned, if you go with the variable rate you stand to save some money in comparison to a fixed rate but you also stand to pay much more depending on what’s happening with the prime rate from the central bank. It’s a risk you have to be willing to take.
Whatever rate you choose will have to work well with your financial lifestyle, if you’re at a point financially where taking some risk feasible a variable rate mortgage could be the way to go. If you are risk adverse and prefer to make the same payments every month stick to a fixed rate mortgage. In the end, whether you go for a variable or fixed rate mortgage, your bank will able to help you choose what suits you best.