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- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
About Fixed vs Variable Rate Mortgages
While mortgage shopping one of the biggest decisions home buyers and mortgage shoppers need to face is whether to select a fixed-rate or variable rate mortgages.
Many people have the question is now a good time for a variable rate? Today we will look at fixed rates vs. variable rate mortgages and the way we choose which is the best one for you.
We will look at what our personal threshold is for choosing a variable over a fixed and about risk tolerance, the number one factor in determining what type of mortgage you should choose.
What's the Difference Between Fixed and Variable Rate Mortgage?
With a fixed-rate mortgage, the mortgage rate and your monthly payment will stay the same for the term of your mortgage. However, with a variable rate mortgage, along with the prime lending rate as set by your lender the mortgage rate will change.
A variable rate mortgage quote will be mentioned as Prime +/- a specified amount. The relationship to prime will stay constant over your term even though the prime-lending rate may fluctuate.
In a Fixed vs Variable Rate Mortgage, How do we Choose the Right one for You?
So risk tolerance is, by all means, the most important thing when it comes to choosing a fixed versus a variable rate mortgage.
So you need to check how would you feel knowing that your interest rate could increase overnight and subsequently, your payments could also increase overnight.
So what happens if interest rates go up by one percent, or 2 percent, or 3 percent, what would that look like from a payment perspective?
To assess for yourself whether it makes sense to take that variable rate mortgage and whether you would be able to withstand the pressure of an increasing interest rate.
Would it Create Stress if the Interest Rates go Up?
You can just go and find a mortgage calculator, put in your mortgage amount, put in your amortization which would be typically 25 years, then put in today’s interest rate which let us consider about 2.25%, and then increase it by half a percent and then again by half a percent, and keep doing it till you start feeling uncomfortable.
And if it is around a percent higher then variable rates are not the best thing for you. If it is about 2%, 3%, or 4% higher, then it is not a good idea to take a variable rate mortgage right now.
So when we talk about variable rate strategy, we are talking about variable rates and about short-term mortgages.
One and the two-year mortgage is a variable rate strategy because we know that the payment and the rates are going to adjust in a year or two, so we look at them the same way that we are looking at a variable rate.
We choose the mortgage that has the lowest rate. Five years fixed were actually the lowest rate on the market, they were priced lower than variable rate mortgages and they were lower-priced compared to one, two, and three-year mortgages.
This was the reason many people choose five years fixed even when the variable rate mortgages were the right choice for them.
Due to the pandemic situation, the variable rates really hit rock bottom but people who picked five years fixed before the pandemic paid a higher rate than what they could have experienced.
So when we are choosing a variable rate strategy by choosing the mortgage that is the cheapest at the time that we get the mortgage.
It is also the cheapest when the mortgage is the biggest because when we are getting a mortgage that is the largest, our mortgage is ever going to be and as w make payments, the amount of principal is going to get paid down and the mortgage is going to get smaller and smaller.
It is always a good idea in taking a lower rate of variable rate strategy when the mortgage is the biggest so we can save the most money.
Where does it really make sense to take a Fixed or Variable Rates Mortgage?
If the interest rates are the same, we can probably benefit from the variable rate strategy, but do we want to take that risk when there is no room for interest rates to go significantly lower?
So we look at is that difference and where we feel comfortable getting variable rate mortgages. Where we feel comfortable if the interest rate is a quarter-point to a half-point lower than what the comparable fixed rate is.
The 3 Things You Need to Consider
- How the lender you are choosing does their lock-in rates?
- What their lock in rates will be? and
- Whether or not you can move the mortgage later down the road if the lender is no longer competitive in their variable rate lock-in rates?
Conclusion
You have to pick a comparable fixed-rate mortgage that is greater in length than the amount of time you have remaining on your mortgage so if you have three years left, you have to pick a 3 year fixed or longer to lock into.
And if the fixed-rate mortgages are not competitive at the lender you have chosen then you could end up having to lock in at a higher rate. So picking the lender that has the best lock in rates is very important.
My cousin is interested in owning a house and he wants to make sure that he’ll be able to pay for it in the future. I like your suggestion of finding a fixed-rate mortgage plan that works for his lifestyle because of how simple they are. I’ll be sure to share this idea with him so he can try it out someday.