Many of us like the idea of buying a home. However, once the process is underway, you have a lot of choices to make. One of the major decisions that you are required to make is whether you want to get a fixed rate loan or a variable rate loan.
There are pros and cons to each type of home loan, and it's important that you understand what comes with each type of loan.
Fixed Rate Home Loans
Fixed rate home loans feature an interest rate that remains the same during a set period of time. In the United States, it's common to see a fixed rate mortgage that lasts the term of a 30-year loan. In other countries, fixed rate loans might work a little differently. The fixed term might be anywhere from one year to 25 years.
During the fixed rate period, the interest rate doesn't change, so you know exactly what you will pay each month. Even if rates rise, your loan rate stays the same. The advantage to the fixed rate loan is that — for the fixed period at least — you know what you will pay, and you don't have to worry about your interest rate going up.
The main down side to the fixed rate loan is that if rates drop, you can't take advantage of the savings unless you can refinance the mortgage. You are pretty much “stuck” with your rate.
Variable Rate Home Loans
Variable rate home loans, on the other hand, change regularly. Many lenders have a specific day chosen out of each quarter or year, and set the mortgage rate based on the market rates of that day. This means that your payment adjusts every time the rate does.
Many variable rate home loans start out at a lower interest rate than fixed rate loans. This can look attractive at first. Additionally, if interest rates drop during your loan, you get to take advantage of a lower payment.
The main disadvantage to variable rate home loans, though, is that you could end up paying a lot more over time if rates go up. You also have to be ready for varying monthly payments from one quarter or year to the next. If you are concerned that interest rates are trending higher, then you will need to make the effort to refinance your mortgage to a fixed rate.
Which Should You Choose?
What you end up deciding on depends on your individual financial situation, as well as what you hope to accomplish with the home. If you plan to stay in your home a long time, a fixed rate mortgage can be a good choice, since you will lock in a longer-term rate to protect you against the very real risk of mortgage rate inflation.
On the other hand, many people who know that they will likely move soon find that variable rates are a good choice. They pay a lower rate, and save money for as long as they are in the home. Of course, the risk is that rates will rise at a faster rate than expected, and that the expected savings aren't realized.
Carefully weigh the risks in your own mind before you get started, and make your decision based on what works best for you.