Fixed-Rate vs. Variable-Rate Mortgage: What’s the difference? And which one should you choose?
One of the major decisions that homebuyers have to make when taking out a loan is whether they would prefer to have a fixed-rate or a variable-rate mortgage.
What’s the difference?
- With a fixed-rate mortgage, the rate and payment you make each month will stay constant until the term of your loan is complete.
- With a variable-rate mortgage, the rate and payment you make each month will fluctuate based on the market interest rate or “prime rate”.
Which one should you choose?
To determine which type of rate you should choose, let’s dive into the pros and cons of fixed and variable rate mortgages.
|Fixed-Rate Mortgage||Variable-Rate Mortgage|
|Pros||Less stressful: you know how much you have to save-up every month to meet your mortgage payment.
Offers stability: whether market rates rise or fall, a fixed-rate mortgage will not be affected.
|More savings: studies have shown that those who have chosen a VRM have saved money in the long run.
Benefit from falling rates: in a decreasing interest rate environment, borrowers with a VRM can benefit from a large amount of savings.
|Cons||Paying a premium: if market interest rates are falling way below your fixed-rate, then you would be over-paying for your mortgage.||Risky: there is a great amount of financial uncertainty. If interests rates rise, your monthly mortgage payments may become a burden.|
Based on this pros and cons list, it is evident that a fixed-rate mortgage is appropriate when market interest rates are on the rise. Additionally, because of their stability, fixed-rate mortgages are suitable for clients who prefer to be risk averse and for those who do not want to monitor the economic wellbeing of the market. Typically, clients who have a psychological need for financial consistency will find themselves more comfortable with a fixed-rate mortgage.
On the other hand, variable-rate mortgages are appropriate when the market is in a decreasing rate environment. However, due to their risky nature, variable-rate mortgages are suitable for clients who are financially flexible and can accommodate a few months of a rising interest rate. Usually, clients who feel comfortable with uncertainty or the “unknown” will find variable-rates more appealing.
There are benefits and downfalls to both variable and fixed interest rates which is why the decision can be a difficult one for many. However, the best thing to do is to choose based on your limits in terms of what you can actually afford with your current income. Your lender will also give you the best advice that he or she can considering your budget, your financial situation, and the market.