Fixed vs Variable Interest Rate Home Loans

Just as you’ve worked your way through those and countless other decisions and you’ve finally found your dream home, your lender throws another mind-bender at you – do you want a fixed-rate or variable interest rate mortgage?

Let’s look at what each of those options offers, and what problems or risks they each carry:

Fixed-Rate Home Loans

Fixed-rate mortgages are the less common option these days. The concept is simple – your interest rate won’t ever change during the life of your home loan.

The biggest benefit of a fixed-rate mortgage is the fact that it offers stability. You’ll always know exactly how much you’ll be paying in principal and interest on your loan.

At the same time, however, fixed-rate loans are a risk to you as the borrower. You’re essentially betting that interest rates won’t drop during the life of your mortgage. Keep in mind that even a percentage point or two can reduce or add to your monthly payment significantly considering the often large loan amount of mortgages.

Another reason fixed-rate mortgages are less popular is the fact that you often have less freedom. If you want to pay more than the required payment (such as to pay off the mortgage early), or want to re-finance to take advantage of a considerable interest rate drop later, your lender will likely tack on huge fees.

Variable-Rate Mortgages

Variable interest rate home loans are the most popular option, despite the unpredictability of how much interest borrowers are going to pay at any given time. If you’re expecting interest rates to drop during the life of your mortgage, a variable-rate home loan can save you a lot of money, where you would otherwise be trapped in a contract to pay more than the then-industry-standard.

A variable-rate mortgage is less of a risk to the lender, because they know they’ll always be able to charge you the highest current rate that new mortgages are going for. They’ll never be trapped into charging you less interest than the current industry standard, so variable-rate loans often offer more freedom. They’ll sometimes also include an even lower introductory interest rate to attract buyers before the start of the regular interest rate cycles.

Split-Rates

If you’re not completely comfortable with choosing between a variable-rate home loan and fixed-rate mortgage, you can choose to combine the two in a split-rate loan. This simply means that a portion of the amount borrowed will accrue interest under a fixed rate, and the rest will accrue interest under variable rates.

No matter what type of interest rate you ultimately choose, choose wisely and with forethought. Trying to change from one type of interest rate to another will usually involve a large fee from the lender, which may completely offset any financial benefits you would otherwise have derived.

Article correct at its author date: June 2008. Copyright Virtual Office Space, Any unauthorised reproduction of this article will be prosecuted to the full extent of the law. Credit Cards Australia.

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