What is the difference between a fixed and variable rate mortgage?

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Simply, a fixed rate mortgage has an interest rate that is kept constant for an agreed duration of time while a variable rate mortgage has an interest rate that can both increase or decrease over time.

Fixed Rate Mortgage Explained

In a fixed rate mortgage, the rate is determined only once and is constant throughout the life of the mortgage loan. Therefore, the rate is not subject to change due to natural fluctuations in the economy. Because the borrower knows exactly what their rate is, the borrower is able to relatively easily budget monthly expenses accordingly.

Variable Rate Mortgage Explained

For a variable rate mortgage, the rate is determined according to a formula that was determined in the agreement. This variable interest rate is linked to the rates present in the market, in other words the economy will cause the rate to both increase and decrease.

Variable interest rates are subject to a degree of volatility because they are related to the value of the market. Therefore, mortgage loans with a variable interest rate will incur a degree of risk. It is important that borrowers who take out a variable rate mortgage loan understand how to track market indicators, so that they can more accurately predict their monthly rates and monthly mortgage loan repayments.

Pros and Cons of Fixed Rates

Fixed interest rates allow for constant, consistent mortgage repayments throughout the duration of the loan. These static payments can allow borrowers to more effectively budget their funds for monthly expenses. Fixed interest rates mean certainty for the borrower.

However, because fixed interest rates do not change, the borrower can miss out from lower mortgage repayments in the event that the lender decreases their rates. Additionally, it can be more costly for borrowers with a fixed interest rate to change banks and/or change rates.

Pros and Cons of Variable Rates

Because variable rate mortgages are linked to the market, borrowers will benefit from lower mortgage repayments when interest rates decrease. Additionally, these mortgages give the borrower a greater degree of flexibility for adding “lump sums” and/or increasing their repayments.

Variable interest rates change over the life of the mortgage loan. This can make it more difficult for the borrower to predict what their mortgage repayment amounts will be each month. Therefore, budgeting expenses each month can be more challenging for the borrower. Additionally, significant increases in interest rates will have a significant impact on mortgage repayment amounts. 

One mortgage is not necessarily better than the other. Simply, fixed rate and variable rate mortgages are different. Therefore, it is important that potential borrowers understand how they compare to each other, and which one is the best fit for them and their lifestyle.