How to Choose Between a Fixed-Rate or Variable-Rate Mortgage
The choice between a fixed or variable-rate mortgage is an important financial decision.
The purpose of this article is to give you a step-by-step definition of each type of mortgage. I’ll also give you some suggestions – things you can consider – in order to choose the right mortgage for you.
Let’s dig in by first defining each type of mortgage.
What is a Fixed-Rate Mortgage?
A fixed-rate mortgage is a loan with an interest rate that does not change for the entire term of the loan. Fixed rate mortgages are usually offered as amortized loans where you make payments on an installment basis.
What is a Variable-Rate Mortgage?
A variable-rate mortgage is a loan with an interest rate that changes according to the interest rate market.
At the fundamental level, The United States Federal Reserve Bank has the most influence on whether rates increase or decrease. They do this by stipulating how much reserves are required in banks and by the volume of U.S. Treasury securities bought and sold each year. Economic and world events also have an impact rates.
Understanding How Interest Rates are Set
I’d like to give you a deeper insight into how lenders make money.
It really comes down to “prime rate,” plus a profit margin. Prime Rate is the lowest rate of interest that money may be borrowed commercially. Usually only large corporations are charged at prime rate due to the volume of money they need, how much money they earn, and how they impact the overall economy.
Banks offering home loans charge their clients prime rate plus an additional rate (necessary for them to make profit). Technically, banks could charge whatever they want. However, in order to remain competitive, they must consider what other banks are charging their clients.
How to Make the Best Choice for You
Here are three points to consider when choosing whether a fixed-rate or variable-rate mortgage is right for you:
Keep Your Finger on The Pulse of The Market
The first consideration is the interest rate market. If interest rates are increasing, you may want to lock in a lower rate which will save you money. If interest rates are decreasing you may opt for a variable-rate mortgage instead because your monthly costs will go down with the market.The best way to keep your finger on the pulse of the interest rate market is to speak with a licensed mortgage officer about your situation. They can ask you the right questions in order to get you the best rate. If you would like to sign up for a one-on-one consultation with me personally, please click this link:Schedule A Consultation
The second best way to stay up to date with mortgage rates is by looking at comparison charts on websites like https://www.bankrate.com/mortgages/.
The key is for you to set aside time each night or day and read on the topic. By the end of 20 days, you’ll have a very clear understanding of the mortgage interest rate market. Therefore, you’ll be able to have the most intelligent and informed conversation with a mortgage broker or officer when it comes time.
Understand Variable-Rate Qualification Process
Variable-rate mortgages tend to be lower. However they’re also harder to qualify for because if rates go up the banks need to be sure you can maintain your monthly payment. In fact, in the application process banks will qualify you for prime rate, plus their standard profit margin, and an additional invisible margin (usually 2%). This additional margin is only to qualify you at higher rate. It’s like a safety precaution that ensures the bank is covering their bases. It’s also the main reason variable-rate loans are harder to qualify for.
There are tools online that can help you get pre-qualified for variable and fixed-rate loans. However, I personally never advise my clients to use those tools. The reason is because if you fail to put in accurate data, you may get a higher rate than you could if you spoke to a real mortgage officer first. Whether you’re speaking to me or someone else, I highly recommend you speak to and retrieve advice from a variety of real licensed mortgage officers.
If you don’t like risk
Some borrowers prefer to lock in their rate for the purpose of maintaining consistent monthly payments. Meaning, they don’t care whether the market is going up or down, they just want to know exactly how much they have to pay each month. Removing the “unknown” from the mortgage equation is likely the reason why amortized fixed-rate mortgages are the most popular for home buyers. Depending on your risk tolerance a fixed rate mortgage may be best for you.
In this article I wanted to define the difference between fixed and variable-rate mortgages. I also wanted to give you some tips and suggestions about how to choose the right mortgage for you. The first and most important advice I’d like to leave you with is to do what you’re doing now: get educated. You’ll ultimately get the best mortgage by learning how the mortgage process works. So, congratulations, you’re on your way to move into your dream home!