If you’ve been looking into buying a home, condo or financing a home improvement project, you’ve probably come across a wealth of different mortgage loan options. But which is best suited to your needs and budget? You can choose a fixed or a variable rate mortgage, but do you understand the implications?

Here, we’ll discuss variable-rate mortgages (aka adjustable-rate) and fixed rate mortgages to help you establish a payment method you can feel secure with.

What’s The Difference Between Fixed Rate and Variable Rate Mortgages?

Variable rate and fixed rate mortgages sound complicated, but they’re really very simple. A variable rate mortgage means that the interest rate changes over time depending on changes in the market rate. With a fixed rate mortgage, the interest rate is locked in from the beginning and it never changes. Both types of mortgages have their ups and downs. Picking the right one depends on your ability to cover changing mortgage rates from one month to the next.

If you need a stable payment schedule, then a fixed rate mortgage is probably best. If you can afford to cover higher or lower payments from month to month, you might save some money with a variable rate mortgage.

Reading Between The Lines

Bankers do throw in some curves that make these loans a little more complicated. For example, a fixed rate mortgage means that your monthly payment will never change until the loan is paid off, but that amount is divided differently by the bank depending on how long you’ve had the loan. During the first few years, most of your payments are applied directly to interest. Only a small amount of each payment is applied directly to the loan until you’ve been paying for at least three years.

Variable rate mortgages have their own language. You have to understand adjustment frequency, which is the time between changes in the interest rate. You need to be aware of the margin, which is the percentage of interest you agree to pay above the market rate. A cap is the biggest increase interest can make in any given month, and the ceiling is the maximum amount of interest that can ever be charged. It’s important to know these special terms before you begin negotiating a variable rate loan so that you can really understand what you’re getting yourself into.

Choosing Your Mortgage

So which type of mortgage is best? As with most financial decisions, it depends. Variable rate mortgages usually allow you to take out bigger loans, and they start out with lower payments. The trouble is that variable rate mortgages are something of a gamble. If the market rates rise unexpectedly, you could wind up paying much more for your house than you expected. Mortgage rates can be unpredictable, which can mean that your monthly bill might be a surprise. If you have a budget with a large cushion, a variable rate mortgage might be your best choice.

If you tend to budget a little more tightly, you should probably stick with a fixed rate mortgage. These mortgages allow you to pay the exact same amount every single month until your loan is paid off. You won’t enjoy the benefits of lower payments if the market is favorable, but you won’t be stuck with outrageous payments if interest rates suddenly start to rise. A fixed rate mortgage makes sense if you plan to own the property for the duration of the loan and you need some stability for your budget.

( Photo from Flickr by woodleywondderworks )

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