When applying for a mortgage, lenders generally offer you the option of a fixed or variable interest rate. Here’s what each one means—and the key differences between the two types of variable rates.
Fixed Rate Mortgages:
With a fixed rate mortgage, your interest rate is set at the beginning of your term and remains unchanged throughout that period.
- Your mortgage payment stays the same every month.
- You’ll know exactly how much of your payment goes toward interest and how much toward your principal.
- It offers predictability and is ideal if you prefer stability and want to lock in a rate.
Variable Rate Mortgages:
With a variable rate mortgage, your interest rate is based on your lender’s prime rate and can fluctuate during your mortgage term. However, there are two types of variable rate products:
1. Adjustable-Rate Mortgage (ARM)
- Both the interest rate and your payment amount change when the lender’s prime rate changes.
- If the rate goes up, your payment increases.
- If the rate goes down, your payment decreases.
- The ratio of interest vs. principal in each payment stays consistent with the rate changes.
- Best for those who want to benefit from falling rates and are comfortable with fluctuating payments.
2. Variable Rate with Static Payments
- Your interest rate may change, but your payment stays the same during the term.
- When rates drop, more of your payment goes toward the principal.
- When rates rise, more goes toward interest, and less to principal.
- If rates increase significantly, you may reach a trigger point, where your static payment no longer covers the interest. At that point, your payment will need to be adjusted.
- This option provides payment stability with some exposure to interest rate movements.
