How to Choose Between a Variable & Fixed Rate Mortgage
With a variable rate mortgage (also called an adjustable rate mortgage, or ARM), the interest rate changes with the market, while a fixed rate mortgage remains consistent throughout the term of the loan. Explore the significant differences between taking a variable versus a fixed rate mortgage to buy your house to make an educated decision on which one best fits your needs.
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Instructions
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Compare the packages offered by your lender or broker carefully. Examine the details of the variable rate offer most closely because it often contains a number of conditions of importance. For instance, the rate may stay fixed at a very low rate for a few years and then start to vary. Find out how often the rate will change, such as monthly, quarterly or yearly. Determine the financial indicator that is tied to the variable rate, such as the prime rate or Treasury bills, and the premium charge (the amount added to the base rate to determine your total rate).
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Decide how long you estimate you'll need the house now that you have the details of both types of loan programs. If the variable rate loan has a low initial rate for five years (lower than the fixed rate loan) and you only plan to stay in the house for about three years, that is one case where you might choose the variable loan. If you're unsure about how long you'll stay or want to stay for a number of years, choose the fixed rate loan.
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Identify your planned use for the property. If you plan to live in the home yourself with your family, a fixed rate may be best because it provides the lowest risk. On the other hand, if you plan to fix up and sell the house soon after taking out the loan as an investment, an ARM with a low initial rate could save you money.
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Examine your employment situation. If it is stable or has a high potential for an increase in income in the future, you may be able to better handle the risk of a potential higher rate associated with a variable rate loan in the future compared to someone who isn't sure about his future job security. If you're unsure, choose a fixed rate to minimize risks.
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Tips & Warnings
When you have the two offered packages from your lender (variable and fixed), run both scenarios through an online mortgage calculator to determine which one has the potential to save you the most money in interest costs over the period of time you plan to stay in the house. Some websites offer variable rate mortgage calculators (see Resources).
