Comparing Fixed And Variable Rate Mortgages

Posted on: 1 August 2017

When buying a new home, there's a whole lot of technical and financial paperwork to deal with, but nothing is more important than the type of mortgage that you will be agreeing to pay. There are two main types of mortgages that most homeowners will end up signing on to, differentiated by the rate at which they charge interest: fixed and variable rate mortgages. Understanding how each works and the differences between the two can help you decide which mortgage is the right fit for your financial needs.

Fixed Rate Mortgages

Fixed rate mortgages, like their name would suggest, fix a single interest rate for the duration of your mortgage. It also fixes the payments that you make, ensuring that you know exactly what you'll be paying years from now, regardless of how the financial markets change in the future. The stability is of course the draw, as this can make it easier for you to plan your financial future.

However, fixed rate mortgages will attach a premium to the interest rate that they charge. This is to make sure that the bank is still guaranteed to make some money, which means that your interest rates and payments may be higher than the financial market would otherwise dictate.

Variable Rate Mortgages

Variable rate mortgages, by contrast, have a constantly fluctuating interest rate, which in turn will increase or decrease your mortgage payments every month, depending on the "prime rate," which is the market's interest rate. The advantage of a variable rate mortgage is that you may end up paying much less in certain months if the prime rate stays low than you otherwise would if your interest rate is fixed. Because the rate fluctuates as the market changes, there is no premium attached for stability. Still, expect to pay slightly more than what the prime rate is – the bank has to make money somehow, after all.

The obvious downside to this is that the prime rate can change unexpectedly, and there is no limit to what your interest payments could look like. This means that you may suddenly find yourself struggling to make payments at a moment's notice, which makes this type of mortgage less than ideal for those without financial security.

Combination of Both Types

Though not always commonly done, it is possible to get a mortgage that is a combination of fixed and variable rates. This allows you to enjoy the benefits of both types of mortgages, switching from one to another after an agreed upon amount of time has passed. While uncommon, this might be the best fit for you depending on your financial situation when buying a new home.