Fixed-rate and variable-rate mortgages are two types of mortgage loans that homeowners use to finance their homes over years. The basic difference between variable rates vs fixed rates is the interest rate. Fixed-rate mortgages have a fixed interest rate that does not fluctuate, no matter the market conditions. Meanwhile, variable-rate mortgages have variable interest rates that fall and rise with the market conditions.
If you’re considering either of these mortgage loans, be sure to consult a leading mortgage broker with extensive experience in helping borrowers finance their properties. If you’re looking to take out a loan that matches your financial goals, The Mortgage Shop can assist.
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The following article will explain the differences between fixed and variable-rate loans, the advantages and disadvantages of these mortgage loans, and whether they might be right for you.
| Fixed Rate | Variable Rate | |
| Interest Rate | Remains at current market rate when you apply. | Initially lower then changes based on market rates and terms. |
| Pros | Monthly payment amounts are established and predictable. | Lower interest rate to start, and monthly payment amounts may decrease. |
| Cons | Beginning interest rate may lead to higher monthly payments. | Monthly payments rise with increasing interest rates. These rates are capped over the loan’s lifetime. |
Understanding a Fixed-Rate Mortgage Loan
What’s a fixed rate? As the name suggests, a fixed-rate mortgage loan has pre-established rates. These interest rates do not change throughout the term of the loan. This means that a borrower can adequately plan for each monthly payment. These standardized monthly payments are great for many loans, whether a mortgage, student loan, or auto loan.
However, because of this guaranteed interest rate, a fixed-rate mortgage will often carry a higher interest rate than a variable-rate mortgage. This predetermined rate is ideal for borrowers who need to protect their personal finance against uncertainty but can afford to take on potentially higher rates.
Advantages of a Fixed Interest Rate Mortgage Loan
Lenders may approve you for anywhere from a six-month fixed-rate mortgage to a 10-year repayment term. The average borrower receives a five-year term from his or her lender. Mortgage rates are typically lower for short-term fixed vs long-term fixed loans.
When economic uncertainty hits or interest rates rise, predictable payments across a set period can be a lifesaver. Most lenders understand just how important one’s personal financial situation is in choosing a stable rate for the life of the loan.
Outside of mortgages, these rates can help with student loans. Students in need of student loans may find a set rate ideal if they have no credit or bad credit. These rates on student loans are determined by the government, and not adjusted based on personal finance like private student loans.
Disadvantages of a Fixed-Rate Loan
These fixed interest rates also come with some negative consequences. If you have a high loan amount, you won’t be able to take advantage of interest rate drops in the market. Again, fixed-rate mortgages start with higher rates than variable or adjustable-rate mortgages, which means you may pay more money over time.
Moreover, if you seek to break your contract and refinance, you may have to pay some hefty fees. Speak with an expert on conventional loans or conforming loans to determine the prime rate, down payment, and loan type for you.
Understanding a Variable Rate Mortgage
Also called an adjustable-rate mortgage (ARM), the variable rate mortgage comes with a variable interest rate that changes based on market conditions. Because these variable interest rates may fall or rise throughout your loan term, periods where interest rates drop can save you significant money.
Whether less interest or more interest, your total cost depends on the benchmark rate and index rate of the markets, your ability to pay, and potentially other factors. The varying interest rate you receive is calculated based on the difference between the lender’s prime rate when you signed the mortgage and the current prime rate.
Advantages of an Adjustable-Rate Mortgage
As previously mentioned, your interest rate changes based on indexes and prime rates. If the market works in your favor, you’ll enjoy a lower rate with a variable interest rate over that of a fixed mortgage loan.
If you want to get out of a variable mortgage contract, you typically need only pay interest on three months of your overall mortgage payment. You can usually switch out to a fixed rate at any time.
Disadvantages of Adjustable Mortgage Rates
The amount of your monthly payment on variable mortgage loans going toward interest can vary widely. With increasing interest rates, you may pay more, and if you attempt to convert out of higher interest rates to a fixed-rate mortgage, you’ll be fixed at that current rate.
Although adjustable-rate mortgages do have caps, these are often set quite high and do very little in countering interest hikes. The interest rate cap structure contains three separate caps. The initial adjustment cap, periodic cap, and lifetime cap may impact your interest rate differently.
What Impacts the Variable Rate Monthly Payment?
What some borrowers don’t understand is that the amount of the monthly payments remains the same. What varies is the amount of those payments allocated to the principal and interest. Higher interest rates receive a greater percentage of the monthly payment; with a lower interest rate, more money goes toward the principal.
If you’d like, you can usually change your adjustable-rate mortgage to a fixed-rate mortgage. You should always consult a broker about changes in interest rates and indexes, such as the Secured Overnight Financing Rate (SOFR) index.
Choosing Between Variable Rate and Fixed Rate Mortgages
The differences between fixed and variable-rate mortgages can be quite stark. If you’re debating a fixed-rate mortgage vs variable mortgage loans, think about your current and future financial situations. Although fixed-rate mortgages are more popular, variable-rate mortgages can lead to lower interest rates and save you more money.
When weighing variable rates vs fixed rates, take into account the following:
Length of Repayment Term – Whereas longer terms will accrue more interest, you’ll likely enjoy lower monthly costs. But what happens if you suddenly have to sell the property? Then you’ll likely owe a penalty. On a fixed-rate mortgage, this penalty is calculated based on the outstanding interest for the term. This can get very high. For a variable-rate mortgage, you’ll only be penalized three months’ interest.
Risk Tolerance and Budget – Compared to variable-rate mortgage loans, fixed-rate loans are better for risk-averse borrowers who want a stable interest rate so they can plan payments in advance. Borrowers should also consider the various lenders and their fees. These may include origination fees, application fees, underwriting fees, and more.
Your current and expected income will also factor into your ability to make a down payment and future mortgage payments. For example, if you have an investor cash flow loan, the long-term reliability of your tenant’s rental payments may impact whether you choose a fixed-rate or adjustable-rate mortgage.
Market Factors – The debate of fixed vs. variable mortgages often hinges on market predictions. Aside from having to pay penalties for breaking contracts, you may end up ‘locking in’ at an unexpectedly high rate, even while market factors bring the rates down. Conversely, fluctuations may make it difficult to properly plan for how much you’ll pay.
If you’re still unsure about whether you need a fixed or variable mortgage, you should contact a seasoned mortgage broker who specializes in no-hassle, easily-qualified loans of all types. From conventional loans to investment credit loans, you have many options for financing your property.
Are you an investor seeking a loan based on investment property cash flow and not income verification? If so, the Debt Service Coverage Ratio (DSCR) loan program may be perfect for your goals. Taking into account the two factors of gross debt service (GDS) ratio and total debt service (TDS) ratio, DSCR loans are great for rental real estate investors.
The majority of lenders handle DSCR loans of all types, with a range of fixed to adjustable rates and payments.
Variable Rates vs Fixed Rates: Making the Final Decision in 2023
The difference between these loans is obvious. While variable mortgage loans have varying rates based on market factors and indexes, fixed-rate mortgages do not. Starting at higher interest rates, fixed-rate mortgages may compensate when interest hikes disproportionately affect variable mortgage borrowers.
Borrowers who prioritize stability and predictability may choose fixed-rate mortgages. However, greater costs and penalties are certainly possible. With variable mortgage loans, borrowers enjoy minimal penalties, greater inter-loan flexibility, and potentially lower costs.
Borrowers should choose based on their risk profile, budget, ownership duration, and market expectations.
Secure The Monthly Payment Right For You
Still unsure about variable rates vs fixed rates? At The Mortgage Shop, we provide a premier line of loan programs ideally suited for any borrower’s needs and goals. If you’re an investor in short-term and long-term rentals, you’ll enjoy our brokerage services. From conventional loans to DSCR loans, Bank Statement loans, and Full Doc loans, we provide the products homeowners and investors need.
Send us a simple message or give us a call and one of our loan specialists will be in contact as soon as possible. Put your headaches and hassles behind you, and finance that perfect property in 2023. Reach out today.
