When you are in the market for a mortgage, the two most common options that will come up are fixed-rate mortgages and variable-rate mortgages. While their names may tell you all that you might need to know about them, there’s more to them than what meets the eye, as is expected from the financial sector. Today, we’ll be taking a closer look at fixed-rate vs adjustable-rate mortgages, what makes them different, their advantages and disadvantages, and which one you should go with if you want to purchase your home. This is a comprehensive breakdown of fixed vs variable mortgages: the differences between the two mortgage types.
But first, let’s take a brief look at what is a mortgage, clear our basics, and then dive deeper into the differences between the two types.
What is a mortgage?
A mortgage is a loan to purchase a property like land, a house, undeveloped real estate, or any holding. It is then paid in a series of payments divided into the principal amount and the interest. These mortgages are common throughout Canada and are the most popular way to purchase your home.
While many types of mortgages are available for different borrowers, the two main types are as follows.
Two main types of mortgages
Based on the rate of interest on the mortgages, the two types are,
Fixed-rate mortgages, as the name implies, are mortgage loans with a fixed interest rate for the entire duration of the mortgage repayment. This is usually for long-term mortgages since it helps keep the costs down for the borrower and allows them to pay a fixed monthly amount towards the mortgage.
Variable rate mortgages
As opposed to fixed-rate mortgages, variable-rate mortgages do not have a fixed interest rate for the entire payoff duration of the mortgage. Instead, the prevailing interest rates will be determined by the market’s prevailing interest rates. In this mortgage type, while your principal amounts will stay the same, the compounded interest on them will fluctuate based on the prevailing rates, and you might have to pay more or less in interest, which can be both beneficial and disadvantageous.
Now, let us take a closer look at both of them and understand the various nuances of these mortgage types.
Fixed-rate mortgages: the advantages
With fixed-rate mortgages, the pre-set interest rates will be applied throughout the amortization period, which is the period of paying off the mortgage. This provides a unique set of benefits, which will be discussed below.
- The peace of mind that comes with fixed-rate mortgages is one of the main benefits. With mortgages, especially long-term mortgages, you will have to pay the premiums monthly, which is a financially draining exercise. However, with the knowledge that these payments are fixed and won’t increase with every passing month, this can come off as a rather reassuring aspect and provides peace of mind for the borrower since they can then plan their budget around the payments, knowing that they won’t change.
- In the same vein as peace of mind, payment predictability is also a great advantage of fixed-rate mortgages. Since your payments will remain the same for the entire amortization period, you will be able to budget more easily and will be able to negate the otherwise negative effects associated with mortgage premiums that may fluctuate frequently.
- Finally, fixed-rate mortgages will save you from any volatility in the interest rate, allowing you to keep yourself shielded from any increase in the interest rate that would make your monthly mortgage payments even higher.
Fixed-rate mortgages: the disadvantages
Fixed-rate mortgages inherently come with some disadvantages, which you should know about. Let’s look at them.
- Since the interest rates are never stable long enough, fixed-rate borrowers may pay more over the long term since the dips in interest rates could lower the interest amount for your mortgage. However, this is only in the long term, and even then, the advantages far outweigh the disadvantages.
Now, we’ll be taking a look at variable-rate mortgages and what advantages or disadvantages they may have.
Variable rate mortgages: the advantages
Variable-rate mortgages, also known as adjustable-rate mortgages, are better for long-term borrowers, as is evident from their advantages. Let’s take a quick look at them.
- The first and foremost advantage is lowering interest rates. If the interest rates are lowered enough, they will be reflected by a big reduction in your mortgage payments. This is very beneficial as you will have to pay less over time, and your payments will be reduced.
- In comparison with a fixed rate mortgage, in variable rate mortgages, the borrower actually ends up paying less over time, which means that if you have a 15- or 30-year mortgage, you are better off having a variable rate mortgage, in which case you will eventually end up paying less.
- Several lending institutions also offer the possibility of switching to a fixed-rate mortgage during the amortization period, so if the interest rates aren’t helping your case, you can always switch to a fixed-rate one.
Now, we will quickly examine the disadvantages of variable-rate mortgages.
Variable rate mortgages: the disadvantages
Given their inherently volatile nature, variable-rate mortgages also come with a couple of disadvantages. Let’s look at them.
- Variable-rate mortgages are better for the borrower if the rates fall, but if they rise, this can and will be reflected in the mortgage repayments, which may balloon, causing financial strain. This is a double-edged sword, and while historically, the interest rates for Canada have stayed low, it is important to bear in mind that they have risen at times as well.
- Since your repayments will not be of a fixed amount, you cannot plan your budget accordingly beforehand, which might not provide you with the peace of mind that other options like fixed-rate mortgages may have.
- Since the interest rates vary, affecting the interest payments, you might take longer to pay off your mortgage, which is a possibility and should be kept in mind while selecting the mortgage type.
Which mortgage type is best for you?
For the new buyer looking to purchase their dream home, all of these options and finance talk may confuse them. However, given the prevailing interest rates and their volatility, the fixed-rate mortgage is the best option if the time period or amortization period is less than 15 or 10 years. If your mortgage exceeds that time frame, the variable rate mortgage will have you pay less over time, meaning that the better option out of the two would be the variable rate mortgage.
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