There are a lot of people getting mortgages in the market today, and those loans can be very confusing. But understanding the difference between fixed rate mortgages and variable rate mortgages isn’t something that you should have to puzzle over yourself. As an expert in the mortgage’s industry, I’m here to outline the pros and cons of both types of mortgages so that you can make a better decision as you’re going through your loan process.

When it comes to determining which, one is a better choice for you, variable rate vs fixed rate, that really depends on your risk tolerance and your personal financial goals and belief system.

Variable Rate Mortgage and An Adjustable-Rate Mortgage

There are two different types of variable rate mortgages whose interest rates can vary, and the way that affects the monthly payments and actual amortization are also different. The two different types of mortgages are Adjustable-Rate Mortgages also known as ARM and true Variable Rate Mortgage also known as VRM.

Adjustable-Rate Mortgages:

An adjustable-rate mortgage (ARM) is a type of mortgage with a variable interest rate. Your monthly payment might go up or down as the interest rate changes.

Benefits:

One of the benefits of an adjustable-rate mortgage (ARM) is that if rates decrease, your payments will decrease as well. This can help increase your cash flow at the end of each month.

Second, you can convert an adjustable-rate mortgage to a fixed interest rate by locking in the interest rate at the time of conversion, which offers you long-term stability.

Another benefit of an adjustable-rate mortgage is that your amortization will never grow, if you continue to make all of your monthly mortgage payments on time.

One more big benefit is that if you decide to prepay your mortgage early, you will most likely be charged only 3 months worth of interest as a prepayment penalty with most mortgage lenders.

Potential Risks:

One of the main risks of an adjustable-rate mortgage is that your payments might fluctuate up or down over time. If the rates rise significantly, so too will your monthly payments. As a result, you might encounter potential financial difficulties down the road. To help mitigate this risk, you can close out your adjustable-rate mortgage at a fixed rate in the future, although at that point the rate may have already grown to a point that makes the monthly payments uncomfortable for you to maintain.

Variable Rate Mortgage:

A true variable rate mortgage (VRM) is a type of mortgage that your interest rate can change, but your monthly payment remains fixed at a specific amount. This means that your monthly payments will remain the same regardless of whether your interest rate changes.

Benefits:

One of the advantages of a variable rate mortgage (VRM) is that you can easily budget your monthly expenses, including a fixed mortgage payment, since your payment will likely never change even if the mortgage rate increases.

Another benefit, similar to an adjustable-rate mortgage, is that you can choose to lock in a fixed rate at any time with most lenders. This way, your rate cannot change.

With a Variable Rate Mortgage if interest rates decrease and stay lower for long enough, you may be able to pay off your mortgage sooner.

A variable-rate mortgage, like an adjustable-rate mortgage, gives you the option of paying off your mortgage early. If you break your mortgage term early, most lenders will only charge you 3 months of interest payments as a penalty. You should remember, however, that some lenders may specify more than 3 months in their mortgage commitment. That’s why it’s important to review your mortgage commitment with your broker before signing it.

Potential Risks:

If your mortgage interest rate goes up, you may find yourself in a negative amortization situation when you refinance, renew, or reach the end of your initial amortization period. Let’s say you take out a mortgage with a 30-year amortization period and fixed monthly payments. If your payments remain fixed, but the interest rate rises, then after 30 years you will not have paid off your entire mortgage and you will still owe money to the lender. This is assuming you are in the same mortgage for the entire amortization period. A variable rate will cost you more in the end than a fixed rate.

If you refinance your mortgage before your amortization period ends, there is a possibility that you could owe more than when you took out the mortgage in the first place. This can happen within the first or fifth year of your loan, depending on when you do it and by how much interest rates go up if they do.

Fixed Rate Mortgages: The Benefits and Risks

If you are looking for a stable monthly payment, a fixed-rate mortgage may be the right choice. The interest rate stays the same, so you don’t have to worry about rate increases. You make the same payment every month, which makes budgeting easier. And because you’re paying down your principal and building equity, your home will be worth more when you sell or refinance in the future.

Some of the potential risks associated with a fixed mortgage are as follows:

• If the mortgage rates decrease, you will still be paying the higher rate and missing out on potential savings.
• If you pay off your mortgage before the end of the term, you may have to pay a prepayment penalty. This can be much higher than if you had chosen a variable-rate mortgage, because with a fixed-rate mortgage, there’s usually a clause stating that you’ll be charged either 3 months’ interest or an interest rate differential for the remainder of your term. Calculating the interest rate differential for the remainder of your term can get quite expensive.

Ask the Experts

All this information is here to keep you informed when making the choice of what type of mortgage loan is right for you. It is up to you now to determine which plan works best for your life and financial situation. Whichever option you choose, make sure that it fits within your budget and helps to provide your family with a stable financial environment.

If you found this information helpful and would like to learn more, our Orchid Financing brokers be happy to get on a call and walk through a series of questions and scenarios that might help you make a more informed decision.

Contact Us to schedule a free consultation today!