Since paying off your mortgage is likely to take a little while, choosing a mortgage that works for your needs is important. Fortunately, there are plenty of options available to suit your specific situation. Our guide can help explain the differences between variable and fixed rate mortgages to allow you to make an informed decision.

What Is a Variable Rate Mortgage?

Variable rate mortgages have rates that can change over the course of time. They fluctuate based on a rate set by the government. Initially, the rates on a variable rate mortgage are lower than the rates on a fixed rate mortgage. This is what makes them so attractive. 

However, those who take out variable rate mortgages are taking on a risk. Typically, the rate you get on a variable rate mortgage is set for a given period of time. After a year or two, though, the rate can go up. It’s also possible the rate could double in a few years’ time. A big increase in rate could add hundreds of dollars to your monthly mortgage payment.

It’s important to note recent news indicates we will soon see increased interest rates on mortgage loans. This means those who take out variable rate mortgages now are more at-risk of seeing increases in the rates than those who have taken out these mortgages in the past.

Who Should Get a Variable Rate Mortgage?

These types of mortgages work well if you plan to sell your home after only a few years. These people are attracted to the smaller monthly payment because they don’t expect to put a sizeable dent in the principal balance of the loan.

Variable rate mortgages also appeal to those who don’t mind a bit of risk in order to get a big reward. The reward is paying less each month, but there’s a big risk of increased payments.

You should only apply for this type of mortgage if you could comfortably afford the monthly payment on a mortgage with an interest rate at least two points higher than the current variable rate. 

Strategies to Make It Work

If you want to win the game, consider paying more than your required monthly payment. For instance, if your variable interest rate is at three percent, you would make a payment that’s roughly equal to what the payment would be if your rate was really five percent. The extra money goes toward the principal balance, so you’re increasing your equity. You’re also conditioning yourself to pay that higher rate, so you won’t be in for a nasty surprise when rates do increase.

You can also keep an eye on rate trends and refinance into a fixed rate mortgage when the rates start to increase. 

What Is a Fixed Rate Mortgage?

Fixed rate mortgages have an interest rate that remains the same throughout the terms of the loan. These rates are slightly higher than the ones you can get with a variable rate mortgage, but it’s a safer option. If your mortgage payment is $2,000 per month, it will remain $2,000 a month throughout the lifetime of the mortgage. 

Who Should Get a Fixed Rate Mortgage?

Fixed rate mortgages appeal to those who are risk-averse. If you don’t want to stress about how you’ll pay a higher monthly payment, the fixed rate mortgage is the right choice for you. These mortgages are also a good choice for those who plan to stay in their homes a long time. Essentially, a fixed rate mortgage is a “safe” choice for pretty much everyone.

Strategies to Make It Work

The bank determines how much you can afford, but it’s important to consider your personal situation as well. When you factor in costs like vacations or school tuition, the bank’s idea of affordability looks decidedly less so. Make your own decisions about an affordable monthly payment.

If possible, pay more than the minimum amount due. This helps you pay the mortgage off faster and decreases the overall amount of interest you have to pay.

What About Open and Closed Mortgages?

Both variable and fixed rate mortgages could be considered open or closed. Open mortgages have no restrictions on paying off the balance early, while closed mortgages have penalties for those who want to pay early. This affects you if you want to add a lump sum payment – like an annual bonus – each year. It can also affect your ability to pay off the mortgage in full through a refinance or by selling your home. 

There’s no one type of mortgage that’s right for everyone. The important thing is to ask your mortgage lender any questions you might have to be sure you fully understand what you’re getting yourself into. When you know the advantages of different types of mortgages, it’s easy to see which one is right for you.

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