For most homeowners, purchasing a home is the single biggest financial commitment made over a lifetime, so it’s no surprise that the process involves a lot of critical decisions. Some of these choices, like
- Neighborhood Selection,
- Square Footage
- Kitchen Style
are a lot of fun. Others, like mortgage selection, might not have the same HGTV appeal, but they are just as important, if not more so. Here is a breakdown of Interest Rate and APR.
Deciding what type of mortgage to take on is a long-term commitment, and in most cases, the choice boils down to one decision: choosing between a fixed-rate or variable interest rate mortgage. The first step to finding out what option suits you best? Understanding the key differences.
What is a Fixed-Rate Mortgage?
True to its name, a fixed-rate mortgage has an interest rate that is “fixed” throughout the life of the loan. This presents both advantages and disadvantages. Rates and payments remain constant despite changes to the interest rate climate, but this stability is often reflected in the initial interest rates.
To safeguard themselves against future losses that rising interest rates may bring, financial institutions generally provide fixed-rate loans with higher initial interest rates than variable-rate mortgages.
If rates go lower, it can be advantageous to refinance a fixed-rate loan, but this involves closing costs, additional paperwork, and other extra fees.
What is a Variable-interest-rate loan?
In contrast to fixed-rate mortgages, the interest on variable-rate loan changes over time, as the rate charged by a variable loan is usually based on an index. This means that monthly payments can go up and down.
The biggest advantages to a variable-rate mortgage are the lower initial interest rate and the ability to take advantage of low-interest rates without refinancing. Of course, these advantages can quickly be flipped on their heads.
Benefiting from low-interest rates is great, but rising interest rates have the opposite effect. Rates and payments are subject to change, and they can rise over the life of the loan.
Fixed vs variable mortgage – What’s best for you?
The fixed-rate vs variable rate mortgage decision depends on several factors. Here are four of the biggest things to take into consideration:
- How long do you anticipate staying in the home?
If you plan on staying in your home for years to come, the stability of a fixed-rate mortgage will likely be worth the initial higher interest.
However, if you plan on flipping the property or moving within a few years, a variable rate interest allows you to take advantage of lower interest, as rates are less likely to change over a short period of time.
- What’s the current interest situation look like?
As a general rule of thumb, fixed-rate mortgages are the way to go when interest rates are below historical averages, as this allows you to lock in at a good price. With variable-rate mortgages, the opposite is true.
- What are the conditions of the loan?
It’s important to know what conditions allow the lender to adjust the rate and payment, and how frequently. Is there a limit on how much it can be adjusted over a certain period? Is there a lifetime limit on how high the interest rate and payment can be raised?
- Can you afford to deal with rising interest rates?
Although fixed-rate mortgages can wind up costing more in the long-run, the overall stability is beneficial when it comes to financial planning. Knowing exactly what you need to pay each month helps you budget your life
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