Fixed vs. Variable Rates

While taking out a mortgage for the first time or remortgaging, you have a critical decision to make. Independent of which lender to go with or how much of an initial down payment to make, the decision of which type of rate to go with could end up being an extremely costly one.

What is the Difference?

The difference between a fixed rate and a variable rate is quite simple. A fixed rate remortgage is a rate that stays the same from the time you make an agreement with your lender and sign on the dotted line. Fixed rates give the borrower the peace of mind of a consistent monthly payment. That payment will not change regardless of what the bank base rate does. The tough prediction to make is when the fixed rate is not going any lower combined with interest rates about to rise.

A variable rate is a rate that can drastically change over the life span of the loan. This rate is tied directly to a bank base rate and has the ability to cost, or save, thousands of dollars. When base rates go down, it is favorable to be in a variable rate situation. Lenders typically want at least a one year agreement locked in on either a fixed rate or variable rate. This is when the tough decision has to be made.

Although a variable rate offers the ability to save thousands off the overall mortgage, it also carries with it the risk of costing thousands. When the bank base rate rises, it might not be possible to change to a fixed rate for several months. Not being able to change during this time could cost the borrower thousands, if the base rate increases quickly.

Locked in for How Long?

The question of how long you are locked into one type rate over another comes up often. As the situation of every borrower is unique and different, so are the combinations of packages a lender is able to offer. Most of the time a minimum of one year is required as to how long a type of rate is locked in for. There are two reasons for this. Lenders do not want to be bogged down doing paperwork associated with changing the rate type constantly. Secondly, lenders can make up lost revenues from borrowers that reap huge benefits of being in a variable rate and base rates falling. These things together make it possible for win-win situations between lenders and borrowers.

Deciding Which Type is Ideal

Since there is no crystal ball to determine what the bank base rate will do, the decision to go with a fixed or variable rate is a challenging one. Many mortgage brokers suggest taking your budget through somewhat of a "stress test" to determine which type of rate is best. If it appears your home budget can take on an increase of up to several hundred dollars more per month, then the risk of going with a variable rate might be worth it. Conversely, if you prefer always having the same house payment amount and you are not much of a risk taker, then a fixed rate mortgage would be best. With an uncertain future ahead, whether you are taking on a first mortgage or in the middle of a remortgage, take time with your decision. Know your situation and understand how choosing a fixed versus variable rate will ultimately affect the financial goals of the household.