Fixed Rate or Variable Rates: When Should You Choose One or the Other?

by khalid on 27/08/2012 · 0 comments

One has to demystify the option of going for fixed rate or variable rate at the time of going for a home loan. This article provides a few handy tips to help you in making an appropriate choice.

Fixed Rate Loans: In the case of fixed rate home loans, your interest rate would remain the same for the entire life of your home loan. Your periodic payments would remain the same for the entire tenure of the loan and the payment would be split into equated monthly payments. However during the first few years, a large part of your repayment would be adjusted towards your interest.

fixed rate or variable rate

Variable Rate Loans: Variable rate loans are popularly called Adjustable Rate Mortgage (ARM). The interest rate on ARMs would change every year.

Fixed or Variable: The question whether fixed rate or variable rate is a better choice depends on a variety of factors. For instance, the choice of fixed rate would be based on the interest rate environment when you have taken out fixed rate loan besides the loan duration.

The interest rate on fixed rate loan would be fixed at the ongoing market interest rate when you enter into your mortgage home loan contract. Besides the lender would add or deduct spread based on unique borrower characteristics. Ideally speaking, fixed rate home loan would be helpful in scenarios where interest rates are low and where the rates are expected to increase. In such situations, it would be better for you to lock into a fixed rate home loan.

Alternatively, if the interest rates are in declining phase, you can opt for variable rate as you will start gaining when the interest rates fall.

You can opt for hybrid ARM that has features of both fixed rate and adjustable mortgages. In hybrid ARM, after the initial fixed rate period, your loan would be amortized over the balance of the loan term where the interest rate would be adjusted annually.

It is important that you understand some of the important aspects of ARM before taking a decision to go for ARM loans. For instance, you should consider the index on which your interest rates would be based. Some of the commonly used indexes are London Interbank Offered Rate (LIBOR), 1-year Treasury Constant Maturity.

You should also consider the margin that would be added to the index to arrive at the ARM interest rate. Next you should keep in mind the aspect called cap. Though the ARM interest rate might be changed periodically, there would be a limit or cap to the amount it can change.

You can also opt for interest-only loan which are structured like ARM. Here you would have the option of paying only the interest for the first few years of the loan. However you can pay a part of your principal amount, if you wish. This option would be suitable for those who believe their income would increase in the near future.

You may carefully spend some time before deciding on the interest type that is most appropriate to your needs. This would certainly save you the trouble of making costly mistakes.

Author Bio:  Allan loves blogging about personal finance. Over the last 4 years, Allan has published numerous articles on home loan refinance, investments and savings. Allan holds a BA in Business Administration with a speciality in banking.

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