When
you’re at the point in your home buying journey and are reviewing different
mortgage loan options, the type of
interest rate will play a big part in your final decision. Mortgage loans come
in fixed and variable interest rate types.
What is an Interest Rate?
Before
we get into the differences between fixed and variable interest rates, let’s
talk about what an interest rate is
related to mortgages. Unless you pay for your home cash in full, you’ll take
out a mortgage loan to pay for the rest after your down payment. This mortgage
loan comes with an interest rate, much like a credit card.
Fixed Mortgage Rates
With
a fixed rate mortgage, your interest rate remains the same throughout the
entire term of your mortgage. You’ll establish this rate with your lender when
you initially apply for and process your mortgage loan. A fixed rate mortgage
results in the exact same payment each month.
Variable Mortgage Rates
Variable
mortgage rates are linked directly to federal mortgage rates (if rates
fluctuate throughout the year). If national interest rates fall during your
mortgage term, so will your mortgage
interest rate. You’ll still pay the same amount each month, but the difference
will be applied to your principal. When the interest rate goes up, more of each
monthly payment goes toward interest; when rates go down, more of each payment
goes towards your principal.
Pros & Cons of Fixed Mortgage
Rates
Pros:
● Consistency: You know exactly what you’ll be paying each month, which
can provide financial stability and peace of mind. You’ll also know exactly how
much of your monthly payment goes towards interest and principal.
Cons:
● May be higher: Fixed rate mortgages can be higher than variable rate
mortgages when you apply and get approved.
● Potential higher costs over time: If national interest rates drop, a variable mortgage will adjust accordingly. But your fixed rate mortgage will not and may ultimately be more expensive than a variable rate mortgage.
Pros & Cons of Variable Mortgage
Rates
Pros:
● Potentially lower costs over time: If interest rates remain the same
or fall throughout the course of your mortgage, your mortgage interest rate
will also fall, and more of your monthly payment will go toward your principal,
resulting in paying off your mortgage faster.
Cons:
● Less Predictable: Since we can’t predict housing market activity and mortgage rates, it’s impossible to know if interest rates will rise or fall over a mortgage term so there’s more risk involved in a variable mortgage rate, especially in turbulent economic times.
In
the end, you’ll need to decide what is most comfortable for you. Knowing where
your monthly payments are going may give you peace of mind and stability. If
you have a fixed mortgage, you might feel discouraged if interest rates drop
and you're not taking advantage of the market. If you’re on the fence, or want
to discuss these options more in-depth, contact us to get connected with one of
our dedicated, licensed loan officers!