Obtaining a mortgage is among the most significant financial obligations you are likely to undertake. Consequently, it’s of utmost importance that you fully comprehend the mortgage that suits you best.
In this article, we will review the pros and cons of two types of mortgages; a fixed rate mortgage and variable rate mortgage. However, before we start let’s define the two types of mortgages.
Fixed rate mortgage: This mortgage charges a constant rate of interest that never changes throughout the loan repayment duration. The principal and interest paid monthly may vary from one payment to the next; nevertheless, the aggregate amount remains fixed, thereby making budgeting easy for homeowners.
Variable rate mortgage: Also referred to as a floating-rate mortgage or adjustable-rate mortgage. This is a loan whose interest rate is subject to change. Monthly payments are adjusted to reflect the current interest rate. Typically, over long time periods, interest rates rise, and such rises cause monthly payments on the variable-mortgage to rise.
Advantages of a fixed-rate mortgage
The main upside of a fixed-rate mortgage is that a borrower is safeguarded from sharp and potentially significant rises in monthly repayments if interest rate surge.
Borrowers of the fixed-rate mortgage know beforehand the monthly repayments they expect to make, thus enabling them to budget over the course of their debt.
Fixed-rate borrowers have more emotional security compared to variable-rate borrowers. A borrower of the latter type of loan may at times have no clue of his/her expected monthly repayment amount, and in some cases, this may lead to future problems.
Disadvantages of a fixed-rate mortgage
The main downside of a fixed-rate debt is the borrower doesn’t benefit from a decline in interest rates, therefore missing out on the resulting lower repayments. The borrower is usually tied for a set period, say five years which they must see out before they can switch to a variable-rate interest loan or refinance or sell their property.
Advantages of variable-rate mortgage
Variable-rate loans have experienced an upsurge in popularity resulting from a rise in home prices. Rising house prices leave many potential homeowners priced out when they attempt to meet the costs of their mortgage with the fixed-rate loans. Variable-rate mortgages tend to have lower introductory interest rates resulting in lower monthly repayments.
It’s easier to qualify for an adjustable-rate mortgage than a fixed-rate mortgage because of the more affordable repayments. Such a situation best applies when interest rates are soaring because the reduced reimbursements enable home buyers to afford expensive homes.
Floating-rate mortgages have a period where the interest rate is considerably lower than the price for a fixed-rate loan. This is referred to as the teaser or introductory rate. The time varies hinging on the loan. After the initial period, the repayments differ depending on the existing market rates.
Disadvantages of variable-rate mortgage
Payment shock is a big risk when dealing with a floating-rate mortgage which occurs when interest rates rise. A sudden surge in interest rates results in increased mortgage payments making putting a financial strain on the borrower.
Variable-rate loans are complicated because they come in an array of terms and choosing the right loan is challenging. Costs aren’t readily comparable, interest rates differ substantially by the lender, and fluctuating interest payments make it arduous to forecast future payments.
For more on mortgages contact Altrua Financial for guidance and financial planning.
In determining the best option, it would be sensible to consider the amortization period of the loan as well as your personal tolerance for interest rate fluctuation.