When it comes to mortgages, interest rates are of utmost importance. You don’t just have to consider the rate, you need to think about the number, too. You can pick between either a variable rate or a fixed rate. Which one is most suitable for you? Let’s find out.
DEFINITION OF A FIXED RATE
When fixed rates are issued, that rate will be assigned for the loan’s lifetime. There is no need to concern yourself with the rate fluctuating or mortgage payments changing (based on a rate). If your insurance and taxes are escrowed, slight changes to payments may transpire as per modifications to those costs.
DEFINITION OF A VARIABLE RATE
As suggested by the name, variable rates can change. The rate will start off fixed, but for a handful of years only. For instance, the fixed rate of a 3/1 ARM stays intact for a few years. The ratemay change annually after that. The amount of the change is contingent on the margin and index. The latter is something chosen by the lender before a loan is funded. For instance, they may select LIBOR as an index. On the dates of rate changes, a lender will use the existing LIBOR rate, then add a predetermined margin to it (perhaps 1% or even 2%). This will be your updated adjusted rate.
CHOOSING THE BEST OPTION
Since you now know how interest rates work, let’s ask some questions in order to establish which rate will be suitable for you:
- How long do you plan on living in the home? Will this purchase be for the long-term, or are you planning on moving in the near future? If you plan on moving, the loan type you should take should be the one with a variable rate. Generally, introductory rates on variable-rate loans are a lot lower in contrast to loans with fixed rates. As such, you will save some money while you are living in the property. If this is a long-term purchase, though, then a fixed-rate loan is what you should select.
- Is job stability a factor? If you are not able to manage fluctuations of variable interest rates, then a fixed-rate loan is what you should stick with. For instance, if the only thing that you can afford is the payment a lender quotes you with, then a fixed-rate loan is what you should get. In doing so, you will not need to concern yourself with higher payments, as well as their affordability. Conversely, if you expect your income to drastically increase after a few years (which tends to happen for lawyers and doctors), then you may be better suited to try out a loan with an adjustable-rate.
- What are the rates currently like? Interest rates happen to be as low as they ever have been, so taking a fixed rate might make sense right now. Your low rate can be enjoyed for the loan’s term. If an adjustable rate is something you take instead, you’re putting yourself at the market’s mercy down the road. Odds are pretty good that a low-interest rate will inevitably be lost.
- Are variable-rate loans the only thing you qualify for? If the debt ratio you have is almost at the maximum; or your credit score is borderline, you might only be eligible for a variable interest rate due to the high debt ratio. The debt ratio would stay low with lower interest rates, giving you an opportunity for loan eligibility.
CONSIDER YOUR FUTURE
Your future is something you need to strongly consider. How do you see things going in the future? Will your career be the same? Will your income be stable? If this is the case, variable rate loans are discouraged because of their uncertainty. If your future plans involve a gradual increase in income, though, then it is possible to reap the rewards that come with variable rates for now, while still having the ability to afford higher rates later on.
Choosing between a variable-rate and fixed-rate loan ultimately comes down to your preferences. Review all the advantages and disadvantages, specifically in relation to your unique circumstances. Don’t rush through historical rate reviews, and speak to professionals for their thoughts and what could happen down the road. In doing so, you can select a rate that is suitable for you over the long run (or for the duration that you reside in the home, at the very least).