Should You Go For A Fixed Or VariableRate Mortgage? (7/30)

No matter what finance experts say about the demerits of home ownership, most of us want to own a home either as an investment or to give ourselves and our families a sense of security. When considering a mortgage, should you go for a fixed rate or a flexible rate mortgage? This post looks at the advantages and disadvantages of each option.

Fixed rate mortgages  are mortgages where the interest rate is fixed for the period of the mortgage. At the time of offer, fixed rate mortgages will have a slightly higher than market interest rate. Fixed interest rate mortgages are attractive for several reasons:

• They come with a level of certainty, and make it easier to plan. If you sign up for a 20-year 15% fixed rate mortgage, you know with certainty how much in interest you will need to pay for the next 20 years and you can plan accordingly. This is perfect for career employees who are assured of a consistent and growing income over a long period.
• If interest rates go up, you are protected with a fixed rate mortgage.
• If interest rates go down, you can easily refinance the mortgage with another institution to take advantage of this decrease. Refinancing however comes at a cost, so it is advisable to consult a financial advisor to help you calculate the saving before you make the decision.

With a fixed rate mortgage, the bank bears most of the interest rate risk, though you may end up paying slightly more if the interest rates keep decreasing over time.

Variable rate mortgages are mortgages where the interest rate fluctuates depending on market interest rates. These mortgages have a lower initial interest rate, but should interest rates go up, you bear higher interest costs. However if they go down or don’t change substantially, you end up paying less than the fixed rate mortgage guys. Refinancing a variable rate mortgage to get a fixed rate mortgage doesn’t give the same advantage as above, because at the time of refinancing, you will have to contend with an even higher fixed mortgage rate compared to what you are paying.

A variable rate mortgage is attractive to the following kind of investors:

1. Short term investors: If you expect to hold the investment for a very short period, then a 20 year interest rate lockdown may not be very attractive to you, because in the short term the interest rate fluctuation may be minimal.

2. Speculators: If you believe interest rates will keep falling and you don’t mind taking the risk, then a variable rate mortgage is for you.

3. Planners or people with windfall earnings: If you have a good strategy to pay off the mortgage within a short time (something I recommend), then go for the variable rate mortgage. People who get substantial annual bonuses would also find a variable rate mortgage attractive.

4. Savers: If you have set aside spare cash that you can use to pay off the mortgage should interest rates go up, then go for the variable rate mortgage.

However, if you’re none of the above and you believe your income will be fixed and predictable for the next couple of years, then a fixed rate mortgage is for you.

I have written quite a bit about home ownership, here is a list of past articles.