Should I get a fixed or variable rate ?

Which is better now, fixed or variable ?


It really depends on a few things such as how long you plan to hold the loan, your sensitivity to risk, and where you think you think the market is going.

If you look at history, right now interest rates are at an incredible low. It's very likely that the people living today will never see another period where interests come back this low. Interest rates have averaged in the 8-10% range with highs in close to the 20%. That and interest rates can't really go much lower because they're pretty much at the same level as inflation (which means there's almost no profit for lenders).

That being said, the reason you normally decide to go with a variable rate is because it's a little lower than fixed. That and when interest rates are declining, you'll get lower and lower interest rates. However once interest rates are at the bottom, well they only have one way to go, UP! Which means that you lose almost all of the advantages of variable rates.

That is to say, as interest rates go down so does your interest rate in a variable rate loan. However, as interest rates go up, so does your interest rate in a variable rate loan! Seeing as they have almost nowhere to go but up, well let's just say they will probably increase. Now, since you do generally get a lower rate than fixed, you have some room for movement. It's just that most people don't realize it's not that much.

Which means that the benefit of fixed rate interest loans are very powerful today. And the longer the term, the more powerful the loan! For example, if you get a fixed rate loan for 5 years at today's historical rates, that's great, but it's really not that long. Although rates have moved quickly in the past, on average they take a while to move.

The real power of a fixed rate loan is over the long term. Imagine being able to lock into a 5% interest loan for 30 years! You can pretty much be guaranteed that interest rates will climb. It's hard to say what will happen in the next few years, but you can know for sure that in at least 5-10 years interest rates will have moved up. You will therefore be getting a lower interest rate for a very long time in exchange for a slightly higher one for at most a few years.

Not only that, but if interest rates climb back up to high levels, you will be locked in at your historical rate. Imagine if you had a 5% mortgage in the 80's when interest rates were at around the 20% mark! But even more importantly, at 5% you would beat the historical average by 3%-5%.

Fixed rates are really good when interest rates are low or are climbing. They aren't so good when interest rates are high or decreasing. Right now we're in a market where interest rates have to go up and they are the lowest ever.

As another note, with fixed rate loans, you're payments are consistent. With variable rate loans, they aren't so consistent. If interest rates increase, you may find yourself owing larger and larger monthly payments for a mortgage, etc. There's definitely some risk there. You are assuming that rates won't go up by more than what you can afford, which in many cases is almost nothing. For example, if you bought the maximum amount of house you could afford, you're in big trouble because you have no extra money to pay any interest rate increases! Hence all the foreclosures today. And it's just beginning.

Another important factor, especially for mortgages, is refinancing. For example, say you take a 5 year mortgage amortized over 30 years. In 5 years you will have to refinance that mortgage. If the interest rates doubles (3% to 6%), which is nothing in today's incredibly low rates, then your monthly mortgage payments will drastically increase! You may not be able to pay them, or even get refinancing. If they go from 4% to say 8%, or 10%, you could be done for. Fixed rates with longer term lock ins will protect you as you don't need to refinance. Just be careful, a 5 year fixed rate mortgage can still result in the same issue, if interest rates have increased you may not be able to get refinancing. Protection against this is longer term rate lock ins.

Views: 2088        Posted on: Apr 05 2012        Tags: Interest Rates, Mortgage, Fixed Rate, Variable Rate