A fixed-rate mortgage and a variable-rate mortgage are two different types of home loans. The main difference between them lies in how the interest rate is determined and whether it remains constant or changes over time.
Here’s a breakdown of each type:
Fixed-Rate Mortgage: A fixed-rate mortgage has an interest rate that remains the same throughout the entire loan term. This means that your monthly mortgage payments will also remain constant over the life of the loan. The interest rate is typically determined at the time of closing and does not change, regardless of any fluctuations in the broader financial market. This provides stability and predictability for homeowners, as they know exactly how much they need to pay each month.
Variable-Rate Mortgage: A variable-rate mortgage, also known as an adjustable-rate mortgage (ARM), has an interest rate that can fluctuate over time. The interest rate is typically tied to a specific financial index, such as the prime rate or the London Interbank Offered Rate (LIBOR). The interest rate on a variable-rate mortgage is usually lower than that of a fixed-rate mortgage initially, but it can change periodically, typically after an initial fixed-rate period. Variable-rate mortgages often have an initial fixed-rate period, such as 5, 7, or 10 years, during which the interest rate remains constant. After this initial period, the interest rate can adjust annually or at regular intervals based on changes in the index. The adjustment is usually subject to certain limits or caps to protect borrowers from drastic rate increases. The advantage of a variable-rate mortgage is that if interest rates decrease, your monthly payments may decrease as well. However, if interest rates rise, your monthly payments could increase, potentially making it more challenging to budget for your mortgage.
Choosing between a fixed-rate and variable-rate mortgage depends on your financial situation, risk tolerance, and market conditions. If you prefer stability and want to know exactly what your monthly payments will be, a fixed-rate mortgage may be the better option. If you are comfortable with potential rate fluctuations and believe that interest rates may decrease in the future, a variable-rate mortgage could be more suitable. It’s important to carefully consider your options and consult with a mortgage professional to determine which type of mortgage aligns with your financial goals and circumstances.